What are the benefits of a sole proprietorship vs. a limited liability corporation?

Recently on our legal forum a user asked, “I am going to open a restaurant, and I am curious what the benefits are of a sole proprietorship vs. creating a limited liability corporation LLC?” 

What is a sole proprietorship?

A sole proprietorship is a legal business entity which allows you to open, start, and operate your own business. It is an unincorporated business and is the most common and simplest business to operate.

To start a sole proprietorship you may not have to take any specific steps, although you will need to review your state’s regulations and licensing requirements to perform certain business functions within your state.

Furthermore, you will need to discuss the tax ramifications of your sole proprietorship with someone who is familiar with federal and state laws and who understands the reporting requirements in your state for this type of ownership arrangement.

Pros and Cons of a Sole Proprietorship

Regardless of the type of business you own, it’s generally going to take a great deal of work to get it started. The good news is there are some benefits to owning a sole proprietorship including the following:

Advantages of owning a Sole Proprietorship

• You do not have any business partners and will have complete control over business operations.
• You will be able to start your business with minimal legal expense.
• You will have limited tax reporting requirements because your business will not be taxed independently.
• You will have complete control over sale or transfer of your business.
• You will have no corporate tax requirements.
• You will have few formal business requirements.

Disadvantages of a Sole Proprietorship

• You will have unlimited personal liability. In fact, because there is no distinct legal separation between you and your business, you could be held personally liable for debts, losses, or lawsuits from the business.
• You may have difficulty raising money for business investments because you will not be able to sell interest or shares in the business. Banks may also be hesitant to loan money to you for certain business ventures due to the increased risk of nonpayment.
• You are solely responsible for the failure and success of your business.
• You may have to rely on personal assets and personal loans to support the business.
• You may lack the expertise or time to grow certain aspects of your business.
• Your business success is closely tied to you. Many sole proprietorships fail to thrive after the initial owner dies or is unable to continue in the business.

What is a limited liability corporation LLC.?

An LLC is a limited liability corporation which offers the limited liability of a corporation but also the pass-through taxation of a partnership or sole proprietorship.

The main benefit of an LLC is the limited liability offered. Specifically, if your LLC is sued and you lose the lawsuit the only assets which are threatened by creditors will be those of the business, not your personal assets (exceptions can exist, however, if you fail to act in a legal, responsible or ethical manner). 

For more information about the pros and cons of an LLC review the information below.

Advantages of an LLC 

• You do not have to be a U.S. citizen to own an LLC.
• You do not have to file a corporate tax return.
• An LLC offers legal personal protection from business debts and obligations.
• Partners, lenders and suppliers have a more favorable opinion of your legal business structure if you have formed an LLC.

Disadvantages of an LLC

• Like a sole proprietorship, you will not be able to issue shares to potential investors, thus potentially limiting the growth of your business.
• There is some lack of uniformity between states.
• Additional taxation of appreciated assets.

How do I know whether an LLC or a sole proprietorship is right for me?

Before deciding what type of business is best for you it’s important to consider several factors including your business’s financial needs, business risks and the ability of the business to grow.  For example, if you need to generate a great deal of capital this might be difficult with a sole proprietorship. Additionally, if you are concerned about protecting your assets, you might want to consider creating an LLC because it will offer more personal protection if your business does not succeed or you are sued by a creditor or employee.

Other issues to consider include taxation, the complexity of starting your business (including the types of licenses, permits and regulations which are required in your state), and how much control you want to run your own business.