After deciding to start a business, you will have a variety of extremely important decisions to make. Among these, one of the most important ones will be deciding what business entity structure to register your company as.
Whilst several exist (including Sole Proprietorships, General Partnerships, Limited Liability Companies (LLCs), and Corporations), most small and medium-sized businesses generally tend to register themselves as either a Sole Proprietorship (for increased flexibility) or as an LLC- due to the plethora of structural and financial benefits involved.
Below we will analytically compare LLCs with Sole Proprietorships, and- in a 2021 context, determine which one is the most favourable option for starting entrepreneurs in the U.S.
Limited Liability Under The Law
When comparing LLCs with sole proprietorships, one of the key distinctions that we will inevitably have to make relates to limited liability. As an LLC is considered to be a separate financial entity to its owner(s) in law, the assets of owners of LLC businesses are entirely protected- regardless of whether the LLC happens to accrue significant debt in the future or declare insolvency.
Of course, this limited liability includes a few exceptions; for one, individuals from certain sectors (such as doctors, lawyers, and architects) are not privy to limited liability under the law.
This is because (traditionally) the U.S’s legislatures have decided that the work of such individuals is of such an important and life-changing nature that society wants them to exercise an exceptionally high degree of care; limited personal liability could inadvertently serve so as to incentivise a directly contrary result.
Additionally, where LLC owners personally guarantee a loan, they contractually forfeit any rights to claim that they have personal limited liability in the future (in regards to that specific loan)- this is commonly mandated by a variety of different lenders.
Finally, the ways in which business owners manage their daily operations can additionally play a vital role in whether limited liability can be claimed.
If certain government bodies- such as the Internal Revenue Service (IRS), conclude that they way in which a business has been operating is pragmatically identical with that of a sole proprietorship, they will commonly revoke any preset limited liability, and may even impose certain discouraging measures- such as back taxes and fines, on the LLC owners involved.
What is a Sole Proprietorship?
When a business is registered as a sole proprietorship, no legal distinction is made between the company and the owner; no separate legal entity is formed, and all business owners involved retain full personal liability under the law for any liability or debt accrued by their company.
According to statistics from the U.S Bureau of Labor, sole proprietorships are currently the most common business entity. This is arguably because of their relatively low set up costs, extremely low procedural rigmarole, and prolific managerial control from a structural standpoint.
The Most Noteworthy Advantages of Sole Proprietorships include:
- No state paperwork– this is subject to any specific licensing procedure that may need to be followed for a specific business (such as DBA filing).
- Decreased scrutiny by U.S federal agencies– such as the IRS, as well as no required annual filing needing to be completed (this can save a significant amount of time for starting entrepreneurs).
- ‘’Pass-through’’ taxation– this means that all profits generated by a sole proprietorship are funnelled directly to the owner(s) of that company, with no corporation tax being paid. As the owners then get taxed once on that stream of revenue on an individual income tax level, they avoid the problem of ‘’double taxation’’ which is commonly experienced by other incorporated business structures (such as Corporations).
What is an LLC?
An LLC, on the other hand, is legally considered to be an entirely separate financial entity from its owner(s). As mentioned above, this means that the owners of an LLC business are protected by the so-called ‘’corporate veil’’, and consequently their personal assets are- subject to the circumstances mentioned above, completely off the table to any past financiers or lenders.
The Most Noteworthy Advantages of LLCs include:
- Increased market credibility
- Limited Liability For Owners
- Increased financing options
- Tax benefits- as a result of the ability of LLC owners to register as self-employed under their own company.
All in all, finding the most optimal business entity structure for you will highly depend on your preferences, business size, and sector. It will also depend on whether you are planning to attain large amounts of financing in the near future, and on how many (if any) business partners you will launch your business with.