According to the Census Bureau, out of all the company applications filed in August 2021, 31,994 new business startups with payroll tax liabilities will form within four quarters. With more businesses being formed, it is important to look at the entrepreneurs preferred business models.
Before setting out on a business venture, an important consideration to make is the type of business you want to start. What are my options? What is the best structure for me and my business personally?
Recent studies suggest that business start ups opt for either an LLC or sole proprietorship status.
What is an LLC and Sole Proprietorship?
An LLC or Limited Liability Company, is a business structure that allows for the personal protection of its members as well as pass through taxation, meaning that owners receive their portion of profits before this money is taxed on a business level.
A sole proprietorship on the other hand, is a far more informal business that isn’t legally separate from its owner. This is the most common form of business structure because of its simplicity.
Sole Proprietorship vs LLC – Pros and Cons
There are definite pros and cons for both LLCs and Sole Proprietorships. Like the name suggests, an LLC offers owners limited liability, which means that if something goes wrong and your business is sued or finds itself in serious debt, your personal assets as the business owner are protected and separate from your business ones.
Another positive of owning an LLC structured business is the way in which your business is taxed. LLCs are subject to pass through taxation and have more taxing options than a sole proprietorship, which means that the company can find a tax strategy that is best suited to the needs of the business.
Customers and banks are more likely to trust an LLC. Being registered as an LLC gives your company more credibility because of its formal business status. This makes it easier to take out loans and increases consumer trust.
Although the way an LLC is taxed can be a pro, it can also be considered a con. The business owner will be taxed in a personal capacity even if they don’t receive a personal disbursement payment.
LLCs also find it more challenging to raise money from outside investors because of the way they are structured.
What about a sole proprietorship? The main advantage here is the fact that starting a sole proprietorship doesn’t require any of the bureaucracy and fees that setting up a formal business does. The owner of a sole proprietorship doesn’t need to worry about fitting in with state regulations or staying up to date with guidelines.
Although this freedom is nice, it comes with some serious risks. Unlike an LLC, sole proprietors have no personal liability protection, which means that if something does go wrong, owners can lose everything, including their personal assets.
There are also no tax benefits that come with a sole proprietorship structured business. Owners will pay taxes on any profits they make as well as their full FICA taxes, meaning that the more profitable your business is, the more expensive it will become to run it from a taxation perspective.
It’s also more difficult to build trust without the backing of a formal business behind you. Banks and consumers are more likely to put their faith and investments into a formally structured business as opposed to an individual running a small scale operation.
So what’s the best option for my business?
At the end of the day, it’s essential to make a decision based not only on the hard facts, but also the needs of your business.
A sole proprietorship is a good option for a new business owner wanting to start a venture on a small scale, or test something out in a low risk environment to determine if it will have greater success.
For a business with a larger customer base, more risks and the potential for instant and sustainable profit, an LLC is a better fit. Although this option involves more paperwork, the rewards and peace of mind are well worth the added effort.
Doing your research is essential before making a final decision. When debating LLC vs sole proprietorship, companies like The Really Useful Information Company (TRUiC) make doing that research just a little bit easier.