The Most Common Business Structures

One of the most important steps in getting your small business off the ground is choosing the right ownership structure for your needs.

In this series, we’ll take a look at the most common structures, and the pros and cons of each.

In today’s installment: sole proprietorships vs. LLCs.

A sole proprietorship is the most common business structure, and the easiest to set up. In fact, you may not have to take any formal action at all in order to make your company a sole proprietorship. All you have to do is start doing business. You’ll need to make sure you’re acting in accordance with applicable laws and obtain any necessary permits and licenses, but otherwise, you can just set up shop. It’s often the easiest and least expensive way to get started.

One of the main arguments for choosing choose a sole proprietorship (as opposed to, say, a corporation) is the manner in which such businesses are taxed. As a sole proprietor, you’ll be subject to “pass-through” taxation, meaning that profits from your business will go directly to you, and will be taxed on your individual income tax return. This situation avoids double taxation, which can sometimes occur in corporations: The company pays taxes on its earnings, and then the dividends paid to shareholders are taxed again as individual income. Sole proprietorships don’t face this problem.

A sole proprietorship is not a legal entity separate from yourself; it merely names you as the one responsible for any debts incurred by your business. This means that, if your venture goes south, your personal assets are at risk.

With that in mind, the appeal of a limited liability company (LLC) starts to become clear. An LLC does exactly what you’d expect: It limits your liability, drawing a clear line between the company’s assets and your own. Whatever may happen in the course of business, if you go with an LLC you’ll only ever be risking the assets of the company (there are exceptions, but this is generally the case).

Another enormous benefit to the LLC structure is that, just like sole proprietorships, LLCs are subject to pass-through taxation. So, with an LLC you won’t get double-taxed, and you’ll receive significant liability protection.

Setting up and maintaining an LLC, as you might expect, can require far more money and effort than a sole proprietorship. There are more legal requirements as well. Form an LLC and you will need to keep meticulous records separating your assets from the company’s (or you’ll risk losing your liability protection). Your company must submit annual reports to the state, and pay fees to maintain your LLC status. If you bring in other owners (not an option with a sole proprietorship, obviously), you’d be well advised to have an attorney create an operating agreement that spells out exactly what each owner’s duties are, how much they’ve invested, and how they will receive profits.

There’s more red tape involved in forming an LLC, but it certainly has its perks. In addition to the principal advantages outlined above (liability protection and pass-through taxation), you’ll likely find that an LLC gives you more options for raising capital. You’ll have access to an extended network through your other owners, and you may be able to sell membership interests as well.

All in all, your choice of business structure should be informed by a thorough and honest appraisal of your company, and of your own strengths and weaknesses as an owner. If you really relish the idea of being your own boss, a sole proprietorship may be the way to go. Still, it’s worth considering whether you might benefit from forming an LLC and bringing in other members. Especially if you are somewhat inexperienced, more seasoned partners may be able to offer invaluable help, advice, and expertise. If you feel confident enough, you also have the option of forming a single-member LLC. That way, you’ll retain the tax benefits and liability protection of an LLC without sharing duties (or profits) with anyone.

Coming up in the next installment: Corporations vs. LLCs.

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