As an entrepreneur, you can either form a sole proprietorship or you can form an LLC. But what is a sole proprietorship and what’s an LLC, and how do you know which of the two is right for you?
A sole proprietorship and an LLC are business structures specifically for small business owners, yet deciding which of the two will be best for your business is dependent on an individual’s personal circumstances and business interest. When deciding whether to form a sole proprietorship or an LLC, it is important to consider how forming a sole proprietorship will benefit you, and when it becomes necessary to formally incorporate your business by converting it to an LLC.
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Forming a sole proprietorship
A sole proprietorship is an informal, unincorporated business entity that is not considered legally separate from its owner. This implies that the business and the owner are one and the same; all profits and losses are reported on the owner’s personal tax return and the owner is liable for all the business’ debt and risk. So as a sole proprietor, you will accept, and be legally responsible for all your business profits and losses. Sole proprietorships are thus the perfect business structure for low-profit and therefore low-risk businesses and businesses that do not have a large customer base made up of as friends, family and neighbors. Sole proprietorships also usually start out as personal hobbies, such as photography or blogging. According to academic research on choosing the right business structure, most sole proprietorships are owned and operated by a single individual. As a sole proprietor, you will therefore conduct business under your own name, or a Doing Business As name (DBA) if you have registered one, you can also hire employees if you obtain an Employer Identification Number (EIN).
When to convert to an LLC
When a business is no longer low-profit and low-risk, the need to incorporate becomes evermore present. Sole proprietors often convert their business into an LLC because their business has grown too much and too profitable to take on the risk of a business without limited liability protection. Yet sole proprietorships have limited growth potential. So if business owners want to expand their business, and have better branding opportunities, then it is time to convert to, or form an LLC. When forming an LLC, the business is considered legally separate from you as the owner; this is one of the biggest differences between an LLC and a sole proprietorship. Unlike sole proprietorships, LLC offer business owners limited liability protection, because the business is legally separate from its owner. LLCs also afford business owners certain tax benefits, such as pass-through taxation and avoiding double taxation. As an LLC business owner, limited liability protection means that you cannot be held personally liable for losses your business may incur and your personal assets, such as your house, car and personal bank account, are protected from seizure in case your business is sued and found financially liable. Forming an LLC that gives you personal liability protection, rather than a sole proprietorship that does not, will allow you to increase your business growth and profits without risking your personal assets, and in general increase your peace of mind with regards to your business.
Personal circumstances dictate whether an LLC or a sole proprietorship is the more appropriate business structure. However, if there are certain things that are non-negotiable for you, like having limited liability protection and gaining certain tax benefits, then forming an LLC rather than a sole proprietorship is the only way to protect your personal assets from seizure, in the event that your business is sued or found liable. If you are still unsure about whether you should form an sole proprietorship or an LLC, TRUiC shows the benefits and drawbacks of both, so it will be a good idea to visit their website.
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