Why Form an LLC Instead of a Sole Proprietorship?

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Sole Proprietorship: The Simplest Type of Business

If your main concern when starting a business is choosing the simplest and least-expensive type of structure, you can’t beat a sole proprietorship. In a sole proprietorship, you are the business — with no legal separation between the two. This type of structure incurs no corporate tax. Instead, the owner pays personal income tax on the company’s profits (along with self-employment tax).

To create some distinction between the business and themselves, owners of sole proprietorships often register a “doing business as” (DBA) name. This allows them to give their business its own name and identity for branding and marketing purposes. The cost of registering a DBA varies from state to state but usually falls between $10 and $100.

While it’s relatively easy and inexpensive to form a sole proprietorship, this business structure leaves its owner’s personal finances at risk. Because there’s no legal separation between the business and the business owner, the owner is liable for any debt the company incurs as well as any damages the company owes stemming from a lawsuit. In some cases, the owner may end up paying out of pocket for these expenses.

Limited Liability Company: An Attractive Alternative

While not the simplest business structure, a limited liability company (LLC) still provides a fairly streamlined option for a small business. In addition, LLCs offer a number of advantages compared to sole proprietorships. These advantages include:

Personal Asset Protection


Probably the most significant advantage an LLC offers compared to a sole proprietorship is the layer of legal protection it provides between the business and its owners. This keeps owners’ personal bank accounts and assets, such as cars or real estate, out of harm’s way in the event the business faces financial trouble. An LLC structure greatly reduces an owner’s risk level, especially as the business grows. As the name suggests, however, this protection is limited. While an LLC business structure isn’t guaranteed to shield an owner from liability in all circumstances, it generally holds up in most cases.

Tax Flexibility


DBA companies receive no tax advantages. Because a DBA isn’t a separate legal entity, its tax status is the same as its owner’s. Owners of LLCs, on the other hand, have several options for the taxation of their business by designating the company as a sole proprietorship, corporation, or partnership. This flexibility enables LLC owners to decide which tax status makes the most sense for their business.

Enhanced Growth Potential


Another benefit of an LLC structure is it can make your business look more professional and credible. This added credibility has the potential to help you secure clients and drive sales.

Improve Ability to Raise Capital


If you need to raise capital or decide to sell your business, you’ll find it much easier to do both as an LLC than as a DBA. Investors will take your business more seriously if it’s set up as its own legal entity.

Forming an LLC Is Easier Than You Think

With all the advantages that forming an LLC can offer, you may be worried that it is a complicated and expensive process. However, forming an LLC can actually be done fairly easily and inexpensively.

Inexpensive Fees


As previously noted, it typically costs between $10 and $100 to register a DBA for a sole proprietorship. While that’s the least expensive option, the cost of forming an LLC generally ranges between $100 and $800 – still a reasonably affordable fee to start a new business. Some states require LLCs to file annual or biennial reports. While these reports usually have fees associated with them, they typically cost less than $100 (check with the proper state regulatory office in your state to determine the exact costs for your LLC).

Simple Paperwork


You must register LLCs at the state level — often with the secretary of state. This typically requires you to file a document called the Articles of Organization (or a similar name, such as Certificate of Formation) that outlines general information about your business. This is a relatively simple process you can either do yourself or hire a third-party professional to help you complete. Once you’re in business, you’ll need to meet limited reporting requirements that usually include a short annual or biennial report document.

Limited Regulations


Unlike corporations, LLCs don’t need to hold director and shareholder meetings or take minutes at any meetings. LLCs must, however, designate a registered agent. While this isn’t a complicated step, it’s one sole proprietorships can skip. LLCs also face very few ownership restrictions. LLCs owners may include other LLCs, corporations, non-U.S. residents, and more.

Start Your LLC Today

If you decide an LLC is the right structure for your business, you just need to follow the following steps to make it official. While the exact process might vary a bit state to state, this list should provide a general idea of what to expect:

  1. Name your LLC. Conduct a business name search to ensure your preferred name is available. Most states provide a business name search tool on their website.

  2. Select a registered agent. This can be a member of the LLC or you may appoint a third party to serve in this role.

  3. File your LLC’s organizing document. Many states call this document the Articles of Organization, but some states use a different name. Whatever the name, it’s usually a fairly short document that provides some general information about your company. Once you file this document and receive state approval, your LLC status is official.

  4. Create an operating agreement. This is an internal document that covers how the company will distribute its profits, its management responsibilities, and more.

  5. Obtain an EIN. An employee identification number (EIN) allows a company to open a business bank account, hire employees, and pay taxes.

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