Starting a new business requires time, effort and answering loads of questions. Among those questions is: which legal structure should I setup for my business? You can come to that answer with just a little preparation and focus. There are two main legal structures that a small business owner should seriously consider, either a sole proprietorship or an LLC. Knowing the pros and cons of each will help you decide and move forward.
The Sole Proprietorship
A sole proprietorship is defined as any business run by one entity without any legal difference between the two. This structure can work for the single entrepreneur whether they outsource multiple functions or do it all alone. The pros of a sole proprietorship are that it’s easy to begin, cost less to start and there’s minimal paperwork involved.
The sole proprietorship does come with drawbacks. If your business were to be sued, your personal assets are at risk. As a sole proprietor, your assets and the business assets are entangled. That means that if someone were to sue your business, they would be able to go after your personal assets including money and property. For example, if you run a one person catering business and a dish you prepared makes someone ill, the victim would be able to sue the business as well as your personal estate for damages. In this case, all of your personal wealth and property would be fair game for any court action. For the small catering business, a sole proprietorship is a risky choice. The owner may be better off using the LLC business structure.
A one or two person catering company may be too small to form a corporation, but the LLC would offer legal protection with less expense, paperwork and tax rules. LLCs are quickly becoming the favorite business structure of small businesses. The LLC is defined as any business structure run by one or more persons that has limited liability and is not taxed as a separate entity from the owners. The LLC structure, limits the liability your company has in the event that legal action is taken against you. What that means is your personal assets are not entangled directly with the business. You, as an entrepreneur, may use your personal assets or money to initially fund the business, but there should be a separation once the business is officially formed.
In the event that someone were to sue you, they’re not necessarily able to sue your estate for damages. The LLC structure offers more protection and still allows you to operate your business within a defined legal structure. You also gain the simpler tax benefits of a partnership as opposed to the more complicated tax rules for a corporation. Forming an LLC, generally requires filing articles of organization. You may also need licenses and permits according to the type of business you run.
For tax purposes, the small business owner normally files business taxes along with their personal return. Most single small business owners will use a Schedule C in addition to their 1040 forms. Those in partnerships will file Form 1065. The IRS considers LLC members self employed and will tax accordingly. Consult a tax attorney or CPA for advice specific to your business, including business losses, deductions and quarterly estimates. Not every business will benefit from an LLC or sole proprietor setup. If you are building your company to take it public and sell stock, you must form a corporation.
The Final Decision
The question of whether or not you should formally make your business a sole proprietorship or an LLC can only be answered by you. It depends on what kind of business you’re running, the potential liabilities and the amount of assets that you have to protect. To find out how other entrepreneurs started, read trade magazines like Fast Company, Entrepreneur and Inc. or listen to reputable business podcasts to hear a variety of experiences.
Check your state laws to determine the requirements for forming an LLC or sole proprietorship. There are websites that allow you to do your paperwork quickly and guide you through the process. With all legal issues; however, the best practice is to consult an attorney. To read more on the advantages or disadvantages of the sole proprietorship vs LLC, refer to the small business administration website.