One of the most common questions we hear from entrepreneurs is: “Should I run my business as a sole proprietorship or form a limited liability company?”
Both of them allow you to be a one-person force, the do-it-all virtuoso, launching your business into the stratosphere with no help from partners or employees.
Even so, there are a few major differences between them so, depending on the nature of your business and its operations, one of them is probably a better fit than the other. And now comes the million-dollar question once again: which one should you choose?
Think of this guide as your personal consultant. It contains all the research, information, and advice you need to make a well-informed decision for your business.
How Are LLCs and Sole Proprietorships Similar?
These business structures overlap in just a few key areas. Most importantly, they’re both commonly formed and operated by a single person. Sole proprietorships, by nature, must include only one person, whereas LLCs can either be single-member LLCs or multi-member LLCs.
When it comes to taxes, there isn’t much difference between these business types either. LLCs have a flexible tax structure, allowing you to choose how the business is classified, but by default, they don’t file separate business tax returns. Instead, LLC members report income and losses on their personal returns, just like a sole proprietorship.
Neither of these business types will be much trouble to form and maintain. Sole proprietorships don’t require any formation documents or fees, while LLC forms are relatively simple. Both are much easier to form than corporations, making them wildly popular structures for new businesses.
These are some significant similarities, but they end there. While they both allow for single-person operation, there are some fairly large differences that are important to consider when choosing a business type.
Advantages of the Sole Proprietorship
A lot of entrepreneurs fall into a sole proprietorship because it’s incredibly easy to do so. Just start working and you’re automatically a sole proprietor, no forms or fees necessary. This doesn’t mean it’s always the best option, but it certainly has its advantages.
No Formal Formation Process: It’s incredibly easy to establish a sole proprietorship. There’s only one step: start working. No need to file paperwork or jump through any government hoops. LLCs require you to draft and file formation documents, then complete annual reports for ongoing compliance. If you hate paperwork, you’ll love the sole proprietorship.
No Fees for Startup or Maintenance: What could be better than no paperwork? No fees. LLCs need to pay startup fees in every state, but sole proprietorships don’t. On top of that, LLCs often pay ongoing maintenance fees like annual reports, but sole proprietorships don’t pay these either.
No Need to Separate Business and Personal Income: When running an LLC, mixing personal and business finances could cause you to lose your limited liability protection. But because you and your sole proprietorship are viewed as the same entity (and sometimes even use the same name), go ahead and intermingle your finances as much as you want.
Advantages of the LLC
Think of it this way: an LLC is a more secure and professional version of a sole proprietorship, but also a version that requires more money and upkeep. If any of the following advantages are important to you and your new business, you might want to consider a single-member LLC:
Personal Asset Protection: Imagine your business being sued and creditors pursuing your house, car, savings, and more. Sounds rough, right? With an LLC, you wouldn’t have to worry about it. This is because an LLC is established as an entity apart from you as an individual. If it’s sued, creditors are restricted to your business assets, not personal ones. Sole proprietorships don’t offer this same protection.
Investment Potential: Quite frankly, investors don’t want to contribute to sole proprietorships because it doesn’t give them any skin in the game. On the flip side, LLCs can sell percentage ownership in the company in exchange for investment capital, and while corporations are king when it comes to venture capitalists, LLCs do attract their fair share of investors.
Expansion and Growth Potential: Say you meet an amazing financial advisor and want to bring her on as a partner in your business. If you run a sole proprietorship, sorry, you can’t. But an LLC can have as many members/owners as you’d like, which makes your expansion and growth goal much more achievable.
Ownership Transfer: If you ever decide to pass along your ownership to another person or group, you certainly can, but only if you run an LLC. With a sole proprietorship, you would have to sell or transfer your business assets one by one because you cannot transfer an entity that is legally an extension of yourself.
Taxation Options: Sole proprietors have one option for tax season: be taxed as a self-employed individual. An LLC lets you choose whether you’d like to have your business taxed as a partnership (similar to a sole proprietorship), C corporation, or S corporation. This way, you can select the option that best suits your budget and financial plans.
How Do I Form an LLC?
Now that you’ve had a chance to weigh the pros and cons of each option, one probably sticks out as the better option for your business. If that option is the LLC, here’s a primer on how to form one.
Your go-to form will be the Articles of Organization (or Certificate of Organization or Certificate of Formation, depending on your state). Each state’s process is slightly different, but generally, the form will ask for the following information:
- Name and physical address of your business
- Name and contact info of your registered agent
- Name(s) of your LLC owner/member(s)
- Identity of your LLC organizer
- Identity of your LLC manager (if applicable)
Each state has its own distinct form for the Articles of Organization, which you can usually find on the Secretary of State website. Familiarize yourself with the state’s specific filing procedures. Most states allow for a variety of filing options, like mail, fax, in-person, online, and more. But some are more particular, requiring mailed documents or only accepting online submissions. Carefully file your state’s guidelines or your document could be rejected. But once you’ve successfully filed and paid the requisite fee, your LLC is ready to go!
What Are the Costs Involved With LLC Formation?
Unlike the sole proprietorship, you can’t get away with forming an LLC for free. How much you’ll pay, however, depends entirely on your state.
You can form an LLC for less than $50 in states like Arkansas and Kentucky, whereas states like Tennessee and Massachusetts impose fees that cost hundreds of dollars. And that’s just for the formation documents.
Depending on the type of business you do, your LLC might also need to obtain certain licenses or permits. A restaurant, for example, requires licensure from a state’s Department of Health. And contractors like electricians also need to obtain licenses from the state before doing business. You guessed it, these licenses also come with a fee.
Typically, there aren’t many required startup costs beyond that. If you’re looking for a detailed cost breakdown, take a look at our guide to state-by-state LLC formation costs.
Hiring a Professional to Form an LLC
There’s no denying that starting and maintaining an LLC adds responsibilities to your plate, especially if you’re tackling the formation process all by yourself. The good news is that you don’t have to do it on your own.
You can always hire a lawyer, for example, to form your limited liability company, which provides some peace of mind that the process will be completed correctly by an expert. On the other hand, lawyer’s fees are usually super expensive, and that can be a prohibitive cost for small businesses.
An LLC service strikes a happy medium. You get experts that will form your LLC without the high fees of an attorney. If you’ve ever looked up LLC services, you probably noticed that there are quite a few companies out there. We waded through them to find the best and more reputable choices for your money:
- ZenBusiness – $39: This is the best overall value you’ll find for LLC formation services. While they don’t have an extensive track record as IncFile (below), they’ve formed thousands of businesses so far and very positive online reviews. They include all the go-to features in every package that entrepreneurs need.
- IncFile – $0: They pair free price points with fully-featured formation packages, including a full year of registered agent service at no additional cost. Add in their top-notch customer reviews, and it’s easy to see why we’re big fans of IncFile’s offerings.
You really can’t go wrong with any of these options. Each one offers top-notch formation services at reasonable prices, so you can hand off those duties without a second thought. Check out their comparison to see them side by side.
At first glance, limited liability companies and sole proprietorships may seem similar, but upon closer examination, they’re far from it. Each has its own unique advantages and drawbacks. At the end of the day, for most business owners, it’s probably worth the expense and hassle to form an LLC, unless you operate a very small, one-person business with no liability or plans for significant growth.
That said, choosing a business structure is a decision you should base on your own unique business and circumstances. Once you’ve thoroughly evaluated your options and weighed the pros and cons, you’re ready to make a well-informed decision for your business.