Sole proprietorship vs LLC vs Corporation
If you have a great business idea in mind, you are probably wondering which business structure fits best. What are the benefits of a Sole Proprietorship? Would it be wiser, in the long run, to structure it as a Limited Liability Company (LLC) or a Corporation? The optimal structure is ultimately one that aligns with your commercial goals and your business’s needs.
So, let’s explore the key differences between Sole Proprietorships, Limited Liability Companies, and Corporations.
A sole proprietorship, as the name suggests, is an unincorporated business structure where the business is owned by one person. There is no legal distinction between the business owner and the business; the owner is personally liable for the obligations and liabilities of the business. For instance, if the business incurs a debt of $10000, the owner is personally liable to the creditor for this sum.
Incorporation is not required. However, depending on the industry in which the business is being operated and the state law, a license or a permit may be required to commence operations.
If the business is conducted under a different name than the legal name of the owner- like a trade name or business name- a ‘Doing Business As’ (DBA) is required. A DBA license allows you to use a name other than your own name for your business. However, you cannot use suffixes such as “Inc.” which falsely indicate that you are an incorporated entity.
Limited liability company
A limited liability company is a formal business structure (created as per state law) where the business is legally distinct from the owner(s). It may have a single owner in the case of a Single-Member LLC, or multiple owners in the case of a Multi-Member LLC.
An LLC combines the perks of a corporation (protection against personal liability) and a partnership (pass-through taxation). Since the business has a separate legal existence, the members are not personally liable for the debts and obligations of the business.
State laws stipulate how LLCs should be incorporated. Some states require certain documents such as the articles of organization, membership agreement, etc., to be filed with the authorities.
An operating agreement is a document that contains all the relevant details about an LLC including the purpose of the business, and the powers, rights, duties, etc., of the members. Operating agreements are not usually required to be filed with the authorities, but some states legally require LLCs to have one on file.
A corporation is a distinct legal entity formed by incorporation; this business entity is entirely distinct from its owners. It is owned by the stockholders, administered by a board of directors, and is run on a day-to-day basis by officers that the board appoints.
Taxes are paid by the corporation, and all the assets and liabilities are the entitlements and liabilities of the corporation in its own right. If a member of a corporation leaves, it does not affect the business.
A corporation has many compliance and record-keeping obligations that it must comply with as per state law. It is best suited for bigger businesses that are scalable and looking to raise institutional finance.
Sole proprietorship vs LLC vs Corporation- key differences
SP: The owner is personally liable for the debts and obligations of the business. This means that the owner’s personal assets can be annexed to discharge these debts or liabilities.
LLC: The assets and personal finances of the members are protected. In the event of losses, liabilities, lawsuits, etc., the personal assets and finances of the members will generally not be exposed to meet the liabilities. However, some courts have held that a single-member LLC will be treated as a sole proprietorship for this purpose.
Corp: Since the corporation is an entirely different legal entity, the stockholders’ assets are protected from liability. The assets of the business entity will be liable for meeting its debts and other liabilities.
SP: The business owner is directly and solely responsible for decision-making and management.
LLC: LLCs are generally managed and controlled by the members based on the operating agreement unless they choose to appoint officers for this purpose.
Corp: They are owned by stockholders but managed by the board of directors that the stockholders appoint. The board decides how the day-to-day affairs of the company are conducted.
SP: The business and the business owner are not separately taxed. All income and losses from the business are required to be reported on the owner’s personal tax returns and will be taxed accordingly. This is called pass-through taxation because the tax liability ‘pass-through to the owner’s tax returns.
LLC: The taxation of LLCs depends on the number of members and how the business has elected to be treated by the IRS. A single-member LLC is taxed in the same manner as a sole proprietorship. Multiple member LLCs are taxed like a partnership, where the members pay taxes based on their contribution to the business (pass-through taxation). An LLC may also elect to change its classification in certain circumstances and can be taxed as a corporation.
Corp: Corporations are taxed separately and are required to file their own tax returns. In many cases, this leads to double taxation as the income of the corporation is taxed, and the dividend paid out to the stockholders is also subject to taxation as their personal income.
SP: Sole Proprietorships find it difficult to raise finance because they are either ineligible to raise investment from institutional investors, or because they are considered less credible borrowers by lenders. Usually, as the business advances, it takes on a different structure such as an LLC, partnership, or corporation.
LLC: LLCs can look at raising finance through equity and debt. They can get new members who will invest in the business, or approach institutional investors to avail traditional loans with a clear business plan. However, if the goal is to raise finance through multiple rounds of investment or by issuing different kinds of stock, a corporation’s structure may be preferable.
Corp: Corporations can raise finance through an Initial Public Offering (IPO) or from institutional investors such as banks, venture capitalists, angel investors, etc., as such investors prefer to invest in corporations. This is because their investments come with various preferences, rights, and protections.
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