Starting a business can be an exciting venture, and to make it even better, there are a few business entity structures that you can choose from. The two most common structures are a limited liability company (LLC) and a sole proprietorship, which offer excellent benefits. After extensive research, we found that an LLC structure is slightly better than a sole proprietorship because of its liability protection and overall ease—but let’s take a look at where both structures shine and fall before you make a decision.
LLC Compared to Sole Proprietorship
There is quite a stark difference between an LLC and a sole proprietorship. An LLC is a separate business entity you legally create under your state’s law, which can have multiple members. An LLC business structure is extremely easy to set up with lower filing and tax costs and offers limited liability and maximum management flexibility.
On the other hand, a sole proprietorship is an unincorporated business structure with one owner and is typically the most inexpensive and easiest way to start a business. You don’t need to worry about excessive paperwork, and you get fewer registration fees—all while retaining complete control and flexibility of your business.
More Top LLC Services
While a sole proprietorship is usually a more inexpensive and simple way to structure your business, an LLC offers many additional services on the market to help you register and get started. After researching dozens of LLC services, we narrowed it down to the top five. If you want to learn more about the services that stood out from the rest, you can see all of our top picks here.
Where LLC Shines
Limited Liability: The most obvious benefit of registering your business as an LLC is that there is a limited liability, which means that you aren’t personally liable for any actions of the company. All the members’ personal assets—whether there’s only one member or four—are protected from creditors that may seek to collect from the business, including assets like cars, homes, bank accounts, or investments of any kind. Liability protection is crucial, and an LLC offers this for the entirety of your business, but only if you manage your finances and keep business and personal financials separate from each other.
Easy Set-Up and Upkeep: An LLC is fairly easy to set up and eventually maintain, with most people finding it easy enough to do so without legal help or additional expertise. The initial paperwork to register an LLC is light, and the fees are generally inexpensive, but this will depend on the state you are registering your business in. The process of setting up your business through an LLC is as low-effort as it gets, especially when it starts with deciding on a business name.
After you have decided on a business name, here is a quick overview of the following steps:
- Find a registered agent
- Get a copy of your state’s LLC article of organization form
- Prepare the organization form
- File the organization form
- Create an operating agreement
- Keep your LLC active
To keep your LLC active, you will need to be mindful of the ongoing requirements, which usually come annually.
Easier to File Taxes: The federal taxation office considers most LLCs as pass-through entities, which means that the business profits go directly to its members without the government taking taxes on a company level. Instead of the government taking from the business directly, each member will pay individual tax profits on their own federal taxable income. Having your business identify as a pass-through entity makes filing taxes much easier because each member is held accountable for their own taxes.
Although it’s easier to file taxes, if your business loses money, you and the other members can claim this on your own tax returns and lower your tax burdens overall.
Management Flexibility: Multiple members will usually make up an LLC, which means that all members can manage the business and share in the day-to-day duties and decision-making—making it an extremely flexible option. Alternatively, if you find that neither you nor your members feel confident enough to manage the day-to-day, you can hire a professional manager. Have peace of mind knowing that a professional with experience is running your business while you work on growing it. Most LLCs are member-managed by default, but you can explicitly state otherwise in your filings with the secretary of state or a registered agent—make sure you discuss these exceptions with the members of your business and go from there.
Lower Filing Costs: In the grand scheme of things, forming an LLC comes with lower filing costs across the board, which is helpful for anyone looking for a more affordable route to starting a business. However, the filing costs will solely depend on what state you are forming your LLC in. The main two costs of forming an LLC are the state filing fee and the fee to file your articles of organization, which both range from $40 to $500. You can form an LLC by yourself or use an LLC service to form one for you for cheaper.
And while an LLC offers lower filing costs, there are other fees you may need to consider, depending on the state, such as business licenses and permits, publication fees, name reservation fees, and a fictitious name fee.
Where LLC Falls Short
High Renewal Fees: While filing costs can be low, LLCs usually have higher renewal fees because you need to renew your business each year to remain at an active status. As always, renewal fees depend on the state, but they usually range from $50 to $260. In most cases, you will have to pay a fee for each member, which can become pricey in the long run, especially if you don’t turn a profit for a long time.
Consequences of Member Turnover: Unfortunately, in many states, if one of your members leaves the business, goes bankrupt, or passes away, you must dissolve what’s left of the LLC. The consequences are dire, considering member turnover is possible for several reasons. Another downside to member turnover is that the remaining members are responsible for all the existing legal and financial obligations necessary to terminate the business appropriately.
On the plus side, all the members can still start and run a business, but they will have to do so under a completely new LLC.
Limited Liability Has a Limit: If you don’t separate your personal and business finances, a judge can rule that your LLC structure doesn’t protect you, meaning that creditors are free to collect any of your assets. You can also be at risk of this ruling if you run your business in a fraudulent way that causes losses for other parties. While this limitation is technically fair, we recommend that beginners seek advice from a financial advisor to protect themselves in the long run if they aren’t sure how to manage their money appropriately.
Where Sole Proprietorship Shines
Less Paperwork to Start: A sole proprietorship is a much easier business route, especially if your business is small. A sole proprietor is self-employed, so unlike other business entities, like LLCs, you don’t need to register with the state or fill out a ton of paperwork—and sometimes you won’t need to fill out anything because you become a business entity simply by doing business. However, similar to an LLC, you may need to register for a business license or permit to begin your services, depending on your current state government legislation.
Whether you need a business permit or not, a sole proprietorship is still an easy way to start a business and scale up much more quickly without government interference.
Fewer Business Fees: A sole proprietorship doesn’t require you to register with the state or fill out much paperwork, so you are already cutting down your fees from the get-go. Unlike LLCs, which need to legally register with the state, a sole proprietor doesn’t need to do this at all. As long as your business doesn’t need liability protection in the future, choosing a sole proprietorship entity structure will almost certainly save you a lot more money in the long run.
Complete Business Control and Flexibility: One of the most common reasons people choose to operate as a sole proprietor is the amount of business control and flexibility you get under this structure. As a one-owner entity, you can run the business however you see fit without a usual formal review process, as long as it’s legal. As a sole proprietor, you won’t need to sit in on annual or board meetings, record minutes, or have shareholder votes.
You also don’t need to worry about finding a registered agent, company officer, or manager. As the sole business owner, you will have total control over the decision-making process, leaving you to focus on your long-term goals and day-to-day operations.
No Annual Reports or Filings: Not only do sole proprietorships have less paperwork and fewer business fees, but this also includes no annual reports or filings, saving you both money and time. You don’t have to file anything other than your tax return, which is quite the contrast to an LLC, which requires you to file annual reports and continually update member lists to remain active. As a sole proprietor, you won’t need to submit an annual audit, a general overview file, when you change manager, or a list of members to continue running your business.
Where Sole Proprietorship Falls Short
No Liability Protection: Since you don’t need to register with the state to become a business entity as a sole proprietor, you end up missing out on the usual business protections that come along with this, such as liability protection. The government considers you self-employed, which means that you are in charge of all business transactions and possible liabilities. Without legal protection, you are personally liable for your entire business entity, including any legal, financial, or tax problems.
Liability protection stops creditors from seizing your personal assets and prevents third parties from suing you personally for business-related issues. Sole proprietorships don’t have access to this protection, creating a huge disadvantage and risk for anyone operating under this structure.
Difficult to Get Financing or Credit: If you need to raise money from outside investors, structuring your business as a sole proprietorship isn’t the best way to get financing or business credit. More often than not, investors want to supply money to an established company because they have a better credit history. As a sole proprietor, you don’t have access to a business credit card or bank account, making it more difficult to build business credit and put yourself out there to get financing.
You also don’t have equity shares or shareholders, and as a business that isn’t formally licensed, investors tend to steer clear of sole proprietors because of these reasons.
No Business Debt: Not having business debt makes it sound like a dream setup, but this isn’t necessarily the case. Because a sole proprietorship isn’t formally licensed, you can’t take out a business loan, meaning all debt—including funds that helped you grow your business—is your personal debt. Most lenders will require you to personally guarantee all loans, meaning they can hold you personally liable and come for your assets if a problem arises.
Lack of Long-Term Structure: Unlike other business entities, if you are a sole proprietor and something happens to you, that is the end of your business altogether. Sole proprietorships offer a lack of long-term structure, which is seen as a disadvantage because most people start a business and want it to continue for the long run. Not having a long-term business structure makes it difficult for you to plan long-term goals and create your exit strategy in the future.
Another downside is that you can’t hire any full-time or W2 employees, except for freelancers. You won’t be able to run payroll or retain employees on a full-time basis, which is unfortunate for anyone wanting to scale in that business structure.
The Final Verdict on LLC Compared to Sole Proprietorship
Overall, we think that structuring your business as an LLC is slightly better than a sole proprietorship. While LLCs can be more expensive than a sole proprietorship, you are essentially paying for legal protection, which is imperative in today’s business world.
Operating your business as an LLC allows you to share duties between members, with flexible management and easy upkeep, while a sole proprietorship is a one-owner structure that offers no protection or long-term continuity.
If you want to start a business, we recommend an LLC structure for the reasons listed above. You can read our full in-depth review on LLC services to help you get started, but here’s a quick overview: