Anybody who is considering starting a business must consider what type of business structure is needed for his or her particular situation. While there are many types of business structures that afford various personal and legal protections, there are two that stand out for the budding entrepreneur.
An LLC, or Limited Liability Company, is a business structure that has become very popular in the last decade because of some of the protections it affords. A sole proprietorship is a business structure often favored by so-called mom-and-pop businesses. Understanding the advantages and disadvantages of each structure is important when deciding which one you want to use for your company.
The first major difference between a sole proprietorship and an LLC is the legal protection that each affords their owners against lawsuits. In a sole proprietorship, the individual owner and the company are one in the same. This means that if someone sues the business, then the personal assets of the owner—car, home, etc.—are fair game in any judgment against the company.
On the other hand, if your company is organized as an LLC, the company is a separate entity from the owner. If a person sues the company, only the assets of the company can be used to pay any legal judgment. The personal assets of the owner are safe.
Of course, this protection is limited. If the owner is personally negligent for wrongdoing by the company, then the liability protection is not going to stop victims of his or her negligence from being able to come after their personal assets.
Most new businesses require some type of capital to get started. Because a sole proprietorship is founded on the name of the person who owns the company, any credit and debt is the sole responsibility of that person. If the business fails and loans cannot be repaid, the owner of the company is completely liable for that bad debt. With an LLC, the business is a separate entity from the owner. This means that if the business should fail, in most cases, the debt would not be the sole responsibility of the owner.
In addition, how a business applies for credit and financing differs with each business entity. With a sole proprietorship, the credit history of the owner is the sole basis in determining whether the business is a good credit risk. If the owner has bad credit, getting the business financed is going to be much more difficult.
Because an LLC is separate from the owner, getting finance can be easier. Especially after the business has been in existence for a few months, many banks will begin to look at the credit record of the company to determine its credit-worthiness. This is obviously a major advantage to the business owner.
Another major difference between these two business entities is the requirements to maintain legal status. Because a sole proprietorship is a business based on the name of the owner, no special fees are typically required. While the business will probably still need to obtain a business license in the area in which it is doing business, the company will not have to draw up a paper declaring its status.
With an LLC, the business will need to register itself as such. In most places, the forms to do this are fairly simple. However, if they are not done properly, this can delay a company’s ability to have limited liability protection. So an attorney will probably be needed to do this properly.
In addition, most states and cities have special fees that must be paid in order to declare the company an LLC. These fees are usually only one-time fees. However, most states have some kind of business or franchise tax that must be paid each year. And because the company will be a registered business, these taxes must be paid.
In the end, deciding which type of business entity is right for you is dependent upon your personal circumstances. Things such as your type of business, where you are doing business, and your personal financial history all come into play. Anyone who is considering starting a business truly should consult an attorney or financial professional to determine which entity is best for his or her situation.