Benefits of an LLC vs. Sole Proprietorship

To be successful, entrepreneurs should familiarize themselves with various aspects of business and law. Contract basics, vicarious liability, and other areas of business law can make or break your business down the road. Before diving into a new venture, however, entrepreneurs must first consider which type of legal ownership structure best suits their business needs. Often, this means choosing between individual ownership and a limited liability company (LLC), partnership or other legal entity.

Sole Proprietorship v. LLC

business woman with filesA sole proprietorship is the simplest way to start a business. You simply make sure to have all necessary governmental licenses or permits, personally obtain any necessary financing, and get to work. All the assets and contracts of the business (such as leases) are placed in your personal name.

On the other hand, creating a limited liability company requires a little more effort. Forming an LLC begins by reserving a name with the Secretary of State’s office, creating and filing articles of organization, and paying a filing fee (typically several hundred dollars). LLCs with multiple members should seek qualified legal advice on drafting an operating agreement to protect all of the owners and the company in the future. LLCs must be sure to carefully maintain corporate records and not to co-mingle business and personal assets and finances in order to protect the owners from personal liability in the event someone contests their LLC status. LLCs must also file separate tax returns from  owners. In most cases, however, the benefits of an LLC are worth the additional effort and expense.

Pros and Cons of a Sole Proprietorship

Many entrepreneurs choose to operate as a sole proprietorship for the ease of use and cost-effectiveness. For example:

  • Sole proprietorships do not require filing articles of organization with the state, payment of filing fees, or corporate documents such as operating agreements
  • Starting a sole proprietorship has fewer initial and ongoing costs and fees than an LLC
  • A sole proprietor may use personal funds and loans to raise capital for the business
  • Income taxes are filed and paid as part of the owner’s personal income tax returns
  • Business assets, contracts, licenses, etc. do not need to be transferred to another entity

However, a sole proprietorship leaves the business owner potentially responsible for all losses, debts, and legal liabilities of the business. Any of one of these risks, should it come to pass, is enough to doom an otherwise successful business. For example, a single lawsuit by a competing business or customer could result in a financially devastating judgment against the owner.

Benefits of Forming an LLC

While starting a business as a sole proprietorship may offer some initial benefits, forming an LLC gives business owners protection from individual liability, thereby substantially reducing the risk to both themselves and their businesses. For that reason, an LLC is typically the preferred method of starting of a business, whether it has one owner or multiple owners. Some reasons why include:

  • LLCs allow pass-through taxation on each member’s individual income tax returns
  • An LLC with multiple owners allows them to pool resources to raise capital, increase credit, and create financial leverage
  • An LLC limits the liability of each owner for legal claims arising out of contract disputes, personal injury claims, business torts and other litigation
  • An LLC may borrow against business assets more readily than individuals
  • With a well-written and thought out operating agreement, LLC owners can agree in advance on all aspects of ownership and operation of the business, reducing the risk to themselves and the business from future disputes

Jay D. Brownstein has over 25 years of experience advising business owners on corporate and contract matters, helping them to manage and avoid legal risks, and representing them in shareholder and partnership disputes and other business litigation. If you’re starting a new business and need help properly setting up an LLC, drafting partnership or other business agreements, or protecting your company in a business dispute, call Brownstein and Nguyen law offices for legal advice.

Businesswoman with Files