LLC vs Sole Proprietorship: What’s Their Difference?
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?” While both business types can be run as one-person companies, there are quite a few major differences between them. Depending on the nature of your business and your plans for its operation, one of them is probably a much better fit than the other. But how do you figure out which one works best for you?
This LLC vs sole proprietorship guide lays out all the important details of these two business structures, with the goal being to help you decide which one you should choose for your company. By the time you’re done reading, we’re confident that you’ll know the answer. Let’s get started!
How Are LLCs and Sole Proprietorships Similar?
To begin with, let’s discuss the ways these two business types overlap. As we mentioned above, the limited liability company and the sole proprietorship are both business structures that are commonly operated by one person ― in the case of the LLC, the one-person version is usually referred to as a single-member LLC, or SMLLC for short.
Another common point is the popularity of these business structures ― the LLC and the sole proprietorship are actually the two most common business types in America. In addition, they’re both much easier to form and maintain than a corporation is. However, this is pretty much where the similarities end…
Advantages of the Sole Proprietorship
There are a handful of ways that the sole proprietorship has clear advantages when compared to the limited liability company. In our opinion, these are the most important ways that the sole proprietorship is the better option:
- No Formal Formation Process: With a sole proprietorship, you don’t need to file any paperwork with the government. The moment you start working, you are automatically considered to be a sole proprietor. With an LLC, you’d need to draft and file documents known as the articles of organization, and most likely file ongoing annual reports as well.
- No Fees for Startup or Maintenance: Every state has a formation fee for LLCs, but none of them have similar fees for sole proprietorships. Along those same lines, the vast majority of states have annual LLC fees for ongoing compliance matters as well, which also do not apply to a sole proprietorship.
- No Need to Separate Business and Personal Income: A sole proprietor can mix their business and personal income as much as they please, because a sole proprietorship is not considered to be a distinct legal entity from its owner. If you own an LLC, you’ll need to keep your business and personal assets separate.
Advantages of the LLC
The single-member LLC also has some advantages that the sole proprietorship can’t match, so if the following factors are important to you, perhaps it’s time to consider forming an SMLLC of your own:
- Personal Asset Protection: The most important advantage of a limited liability company is the fact that it provides personal asset protection. If your LLC is sued, your creditors are strictly limited to pursuing your business assets, while your personal assets (car, house, personal bank accounts) are off-limits. This is not the case for sole proprietorships, as any of your assets are fair game if you’re sued as a sole proprietor.
- Investment Potential: Because the sole proprietorship is not considered to be a separate entity from the person who operates it, hardly anyone ever invests in them. With an LLC, you can sell percentage ownership in the company in exchange for investment capital, and while they’re not nearly as popular as corporations for venture capitalists, LLCs do attract their fair share of VC as well.
- Expansion and Growth Potential: If you ever decide to take on partners in your business, you certainly can’t do that with a sole proprietorship. An LLC can have as many member/owners as you’d like, which makes the concepts of expansion and growth much more realistic than they are for a sole proprietor.
- Ownership Transfer: Continuing along those lines, the LLC can be easily sold or transferred from one ownership group to another. 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, which is to be taxed as a self-employed individual. With an LLC, you can choose to be taxed as a partnership (which is very similar to sole proprietorship taxes), or you can elect to be taxed as a corporation (with your choice of C corp or S corp taxation).
How Do I Form an LLC?
If you’ve decided that the limited liability company is the best option for your business, you can form one by preparing and filing the articles of organization. While each state has a slightly different process, for the most part this is the information you’ll need to include:
- 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)
In most states, you can find a template for the articles of organization on their Secretary of State’s website, but in others you may need to create your own from scratch. Once you have completed your articles, you can file them with your state government for a small fee, and your LLC is ready to go!
What Are the Costs Involved With LLC Formation?
Each state charges its own filing fee to form your limited liability company, which vary considerably depending on which state you select. You can form an LLC for less than $50 in states like Arkansas and Kentucky, whereas in other states like Tennessee and Massachusetts, you’ll need to pay hundreds of dollars to form your new business. If you’re looking for a detailed cost breakdown, take a look at our guide to state-by-state LLC formation costs.
Hiring an LLC Formation Service
If you want to form an LLC, but you don’t want to tackle the DIY route, you still have plenty of options. You can always hire a lawyer to form your limited liability company, which does provide some solid peace of mind that the process was completed correctly by an expert. On the other hand, lawyer’s fees are super-expensive, and that can be a prohibitive cost for small businesses.
The other option is to hire an LLC formation service online. There are plenty of reputable companies that can form your LLC at a fraction of the cost compared to an attorney, while still giving you the professional formation you’re looking for. If you would like to select this option, we recommend taking a look at one of the following companies:
- IncFile – $49: They pair low 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 what IncFile has to offer.
- Northwest Registered Agent – $79: Northwest also packages in a year of registered agent service with any LLC formation purchase, and they even locally scan every document they receive on your behalf, whereas most competitors only scan the government docs they’re required to. Their claim to fame is their highly personalized one-on-one customer support, which makes their price tag worth it in our opinion.
- LegalZoom – $149: LegalZoom has some admittedly high prices, but their massive brand power and customer volume speak for themselves. Throw in their 100% satisfaction guarantee and extended customer service availability, and you can see why so many entrepreneurs think LegalZoom is worth the price.
While the limited liability company and sole proprietorship do have plenty of common points, they each also have their own advantages over the other. 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 that doesn’t have any liability or plans for significant growth.