One of the first decisions a person has to make when they decide to start a business is what type of structure they’re going to use. For most aspiring entrepreneurs, the two most common structures they’ll consider are the sole proprietorship and the limited liability company.
Both of these structures are suitable for new businesses, but there are distinct differences that must be considered. Understanding those differences is critical.
What is a sole proprietorship?
A sole proprietorship is the most basic business structure. It’s suitable when only one person owns the business. The business income is reported on their tax return. This is often an appealing option because it is fast, inexpensive and doesn’t require much work. Many people who use this business structure are freelancers, contractors and those who have very small businesses.
A sole proprietorship’s downside is that there isn’t a legal separation between the owner’s personal assets and the business’ liabilities. This means that a lawsuit against the company can result in the owner losing their own personal assets.
What is a limited liability company?
A limited liability company requires specific forms to be filed along with fees. There are ongoing requirements for compliance that aren’t present in a sole proprietorship. The benefit of this business structure is that it creates a dividing line between the business and the owner. Establishing the company under this structure can also make it appear more formal to clients and lenders, which is important for growing companies.
This type of business structure can include more than one owner, which makes it an option for a partnership. If there’s only one owner, the taxes can pass through the owner’s income taxes. It’s also possible for limited liability companies to be taxed as corporations. The tax implications can be significant, so they must be carefully considered.
Determining the business structure is only one consideration when starting a business. Working with someone familiar with these matters is critical so they can assist with determining what steps to take to protect the company and the aspiring entrepreneur.