A sole proprietorship is the most widely spread form of running a business in the US allowing you to legally operate beyond business incorporation. The majority of startup projects and smaller ventures begin as sole proprietors. Most often than not, it happens so to say naturally since entrepreneurs have no specific business plan in place and simply start selling goods or providing some payable services. Eventually, many of them make the next move and incorporate an LLC company. However, when is the right time to realize the conversion is still a burning question for many entrepreneurs. While LLC formation services make LLC creation as easy as it might get, to answer that question, it’s important to clearly see and understand the difference between a sole proprietorship and a limited liability company as well as if that move is worth the gain.
Sole Proprietorship and LLC Formation: How They Stack up
These two most popular business forms still raise many disputes among beginner businessmen who are contemplating the best structure for their future or existing business venture. Starting a business, many would choose between a sole proprietorship and an LLC. While some start as sole proprietors by default, others go for LLC formation from the very beginning.
A sole proprietorship is an unincorporated business structure. You don’t have to file it with the state, and it’s not a legal entity in fact. What is it then? Your business in this case is you. While sole proprietorships are single-owner businesses, they are named after their owners. As a solopreneur, you can have workers and employees but you can’t have partners, which means you are the only one both to gain profit and to bear responsibility for your business. Noteworthy, you are free to choose to run your business under some other name, and then, you’ll have to file a DBA.
By way of contrast, an LLC company is an incorporated business structure that needs to be registered with the state. It functions as an independent legal entity separate from its organizers. There are single-owner and multiple-owner LLCs, and the best thing is the number of members is not limited, which is great news if you want to add some co-owners on the way. Business incorporation entrusts all the company-related liabilities solely to the company as a legal person keeping you exempt from those obligations.
Sole Proprietorship and an LLC: How Are They Different
To get a better vision of each business form, see how those forms stack up in close comparison:
- Management System: Both business forms boast a simple and straightforward management structure giving the business organizers full control over their companies. As a sole proprietor, you are the only boss with no partners to deal and agree with. An LLC company allows its members to jointly manage the business or hire a third-party manager for day-to-day operations. The latter is appropriate for multiple-member LLCs. Besides, to avoid any disagreements, misunderstandings, and internal conflicts, it’s essential that LLC members sign an Operating Agreement upon the LLC creation that will outline all the vital management aspects;
- Personal Commitments: This is where the main difference between a sole proprietorship and an LLC lies. As a sole proprietor, you are the one with your business, and you are personally to tackle all the issues and problems that come up on your business route. It means you’ll be responsible for all the legal issues and financial debts of your legal entity. An LLC company, on the other hand, provides secure personal liability protection. Since you are associated with your venture only as its owner, you have no personal obligations to the financial and legal problems of your business. And your personal assets are at no risk to be used for settling those company problems;
- Funds Allocation: A sole proprietorship doesn’t distinguish between individual and entity funds. In the eyes of the law, they are the same. Meanwhile, the establishment of a corporation or LLC enables you to distinctly split your own and company funds by opening a business bank account. It’s the easiest way to account for the business income and cash flows;
- Taxation: At a glance, a sole proprietorship and an LLC company look pretty much the same in this concern. Both business forms are pass-through entities for tax purposes, i.e. the company income is reported on the personal tax returns of its owners. However, they are not the same here. Such taxation scheme is the only option for a sole proprietor while LLC incorporation brings flexibility and allows you to select an S-Corp status for your company to optimize taxes to handle higher profits and meet growing business needs. The plus you’ll get with a sole proprietorship, though, is that there is no income tax to pay. You’ll only pay taxes on business profit.
When to Initiate LLC Formation?
Different from a sole proprietorship in many key aspects, an LLC company also helps build better business credibility and looks a more reliable structure in the eyes of banks, financial institutions, and target customer audience. Besides, LLC incorporation brings better funding opportunities. If your business needs some additional financing, you can always get it by attracting some more company members. And banks are more eager to issue credits to incorporated business structures than unincorporated ones. As such, LLC formation is a better choice for a business targeting future growth and might be a nice option from the very beginning if you already have well-set business plans at hand. And LLC formations services can make it an easy path for you.
If you initiated business as a sole proprietor anyway, the best time to switch to an LLC would be once you have a relatively large customer base and achieve sustainably high profit. All of this entangles higher levels of financial risks and calls for a higher level of personal protection accordingly. Just try to launch an LLC formation at the beginning of the year to avoid filing two tax reports.
Forming an LLC: DIY Method or LLC Services
When thinking about LLC creation, many entrepreneurs loathe the formalities and paperwork routines waiting for them ahead while others are not sure they can handle the whole process on their own and delay it for as long as possible. To dispel all your worries, LLC incorporation is quite a feasible process to complete by yourself. It just needs time and an eye for detail. You can’t but agree that choosing and checking the company’s name, appointing a registered agent, and filing a Certificate of Formation with the state is not much of a hassle. However, if you do want professionals to do that job, hiring one of the LLC creation services is certainly the best option. The best LLC services such as LegalZoom or Rocketlawyer will not only complete all the formation formalities but also offer a wide range of maintenance services to legally activate your new company and keep it compliant after LLC formation is over.