Sole Proprietorship + Corporation = LLC
To understand the benefits of registering your business as a limited liability company, it’s important to understand the alternatives. The simplest and most common business structure is a sole proprietorship or general partnership, while the most formal structure is a corporation. Somewhere in the middle lies the limited liability company.
Sole proprietorships and general partnerships do not come with any specific requirements. In this structure, there is no distinction between the business owner(s) and the company, and thus, no distinction between your assets and that of your business. This can be appealing to those who run very small businesses and do not want to worry about maintaining separate finances, paying fees, or following state regulations. It can be problematic, however, if your business goes bankrupt or gets sued, since your personal assets will not be protecting from seizure.
On the other side of the spectrum is the corporation. To form a corporation, you must file articles of incorporation with your state and follow a series of formal business practices. Once your corporation is approved, your business officially becomes a separate legal entity from you and your shareholders. This distinction creates what is known as the corporate veil, dividing your personal assets from your corporate assets. This division means your personal assets will be protected in the event that any legal action is taken against your company.
Benefits of a Single-Member LLC
Most people who choose to form LLCs do so for the limit liability protection they provide. Just like a multi-member LLC, a single-member LLC creates a corporate veil, which can protect your personal assets from liabilities that arise in the course of doing business. Generally speaking, you will be protected from:
- Contractual liability: This refers to anything your business has contractually agreed to, such as supplier agreements or bank loans. If you are unable to meet the terms of these agreements, your personal assets will be protected in the event of legal action to recover damages or debts.
- Tort liability: This type of liability occurs when one person commits wrongdoing against another. In the case of a single-member LLC, your personal assets are protected in the event that one of your employees causes harm as a result of negligence or other wrongdoing in the course of doing business.
Benefits Over Other Business Structures
Beyond these protections, choosing a single-member LLC over another business type such as a sole proprietorship or a corporation offers several additional benefits.
- Investment opportunities: Registered businesses often carry increased stature in the minds of potential investors. It is generally more difficult to attract investment funds to a sole proprietorship than to an LLC.
- Credibility: As a single business owner, registering as an LLC can also add credibility to your operation in the eyes of prospective customers. Many people feel more comfortable working with a business rather than an individual.
- Flexible taxation: A single-member LLC can choose to be taxed as either a sole proprietor or a corporation, depending on what format will produce the best financial outcome. This decision should be made under the advisement of a tax professional.
- Flexible ownership: Unlike a sole proprietorship, a single-member LLC can be owned by either a person or a single entity such as another LLC or a corporation.
- Ease of doing business: While a single-member LLC offers the limited liability protection of a corporation, it is not required to follow the same formalities, such as issuing stock, creating and adopting bylaws, and holding annual shareholder meetings.
Have a professional service form your LLC
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Limitations of a Single-Member LLC
A single-member LLC comes with many benefits. However, it also has several limitations. A single-member LLC does not protect you in the following situations.
- Personal torts: While your LLC will protect your personal assets if one of your employees has legal action brought against them, you will be liable for all personal torts that result from deliberate or negligent harm to others when you are working on behalf of your business.
- Personal guarantees: As the owner of a single-member LLC, you will retain liability for any personal guarantees or pledges you make to a financial institution or lender and any contracts you sign as yourself rather than your business.
- Outside liability: While most people think of limited liability protection as a way to shield personal assets from business liabilities, multi-member LLCs offer something called charging order protection. This protects business assets from personal liabilities. If one partner faces financial trouble, this rule prevents personal creditors from seizing more than that one person’s share of the company profits. Because single-member LLC owners operate on their own, this protection does not apply to them. In most states, your corporate veil can be pierced from the outside and your business assets seized to settle personal debts.
- Fraudulent or illegal activities: Like personal tort liability, you will retain personal liability in the event that you commit any fraudulent or illegal activities in the course of doing business.
Protecting Yourself in a Single-Member LLC
LLCs were first conceived as partnerships, so while single-member LLCs are universally permitted across the United States, in practice it can be more difficult to protect your assets when faced with legal action. Protecting yourself comes down to strict attention to detail and impeccable record keeping. Below are some of the ways you can help maximize the benefits and protections of a single-member LLC.
- Do not blur personal and business lines. As a single-member LLC, it can be very difficult to keep your business and personal finances completely separate. However, this is the most important thing you can do to remain in compliance and retain your personal asset protection. Make sure to request a federal employer identification number (EIN), open separate business bank accounts, and always sign business contracts on behalf of your LLC, not as yourself. All business-related documents, including checks, contracts, purchase orders, and bids, should bear the name of your business followed by LLC.
- Create an operating agreement. It may seem counterintuitive to create an operating agreement as a sole business owner, but it is actually even more important. This document is designed to dictate how your company functions, and while it is not required, it can go a long way toward proving the legitimacy of your business and protecting your corporate veil in the courtroom.
- Remain compliant. While LLCs are fairly simple to maintain, it is vital to stay current and compliant with all state reporting requirements, tax liabilities, and other regulations to retain your legal protections.
- Purchase business insurance. Despite the protections built into your LLC, it is still always a good idea to carry liability insurance. Since courts have historically had an easier time piercing the corporate veil of single-member LLCs, liability insurance can offer you an extra layer of protection if your business runs into any financial or legal trouble.
Who Is This Structure Right For?
A single-member LLC is a great business structure for any business owner who can benefit from limited liability protection, wants to build more legitimacy around their business, or is looking for a flexible tax structure.
When it comes to individual entrepreneurs, converting from a sole proprietorship to an LLC can benefit almost any business type. From dog walkers to personal assistants to content creators, there are few downsides to giving yourself the added protection and legitimacy an LLC provides. However, some sole proprietors will benefit more than others. When deciding whether the single-member LLC is right for you, consider the following:
- Does your business create personal risk? Some businesses are riskier than others and will benefit more from the limited liability protection offered by an LLC. For example, if you work in construction, personal care, pet care, or own one or more rental properties, a single-member LLC is a smart move.
- Can you keep your assets separate? When it comes to LLC protections if you can’t keep your business and personal interests separate they are effectively null and void. Before forming a single-member LLC you should consider the feasibility of doing this. If you run a side business that brings in a very low income and has few business expenses, it may not be worth the effort to create separate accounts and financial records.
Businesses with Multiple Ventures
Beyond sole proprietors, the single-member LLC can also be a great tool for business owners who already own an LLC or corporation. In many cases, these owners can benefit from a parent-subsidiary LLC structure.
This is a good move for businesses with multiple ventures, such as real estate investors and developers, restaurant groups, and movie or TV studies. Under this system, the parent company serves as the owner of one or more single-member LLCs. By doing this, the business owner is able to protect each branch of the business from any problems that arise with the others, retain personal liability protection for themselves, and enjoy the simplified and flexible taxation structure offered by an LLC.
The LLC is an extremely popular business structure for a reason. It is easy to form and maintain, offers attractive liability protection and flexible taxation options, and lends itself well to almost any type of business. Whether you are a sole proprietor looking to take the next step in solidifying your business or an established business owner looking to expand or organize your multiple ventures, a single-member LLC can be an excellent choice. While this structure comes with its limitations, many of them can be overcome by diligent compliance with the business requirements. If you think this structure is right for you, continue on to learn how to form an LLC.