Companies of all sizes have one thing in common: They all began as small businesses. Starting small is the corner for those just getting off the ground. Learn about how to make that first hire, deal with all things administrative, and set yourself up for success.
Despite the hardships COVID-19 has brought to the economy, many people have chosen this time to become entrepreneurs. Entrepreneurship brings new ideas, greater competition, and increased job creation. However, when it comes to starting your own business, there are countless considerations that will determine your company’s success, including the way it’s structured.
Determining your business structure, or the way your organization will be legally recognized, is a first step in launching a business. Sole proprietorships and limited liability companies (LLCs) are two business structures typically used by entrepreneurs as a starting point, and this article explores their differences, benefits, and drawbacks.
What is an LLC?
An LLC reduces the risk of its owners, shielding them from liability in the case of legal action or bankruptcy (more on this below). An LLC must be registered with the state, and the expenses and paperwork involved in registration vary according to state law. Individuals, groups of people, and corporations can form LLCs, and all members must declare income and losses on their personal tax returns—LLCs do not pay taxes themselves. Owners of LLCs (called “members”) have more freedom than owners of corporations, who have to go through a board of directors to make drastic changes.
What is a sole proprietorship?
A sole proprietorship is the easiest type of business to start, as it requires no formal registration. This business structure is tied to you as an individual, and you have complete control over its direction and growth. This freedom comes with responsibility; as the owner of a sole proprietorship, you are personally accountable for paying taxes on the business, and you’re also legally liable if any contingencies should arise.
LLC or sole proprietorship? Five questions to ask to help make the right choice
There are several considerations in determining the best business structure for your startup, including:
Do you need personal liability protection?
One of the major differentiating factors between sole proprietorships and LLCs is the liability of the business owner.
Sole proprietorship: As a sole proprietor, you are personally liable for any debts the business accrues, or if the company is sued for legal reasons. This means personal assets—including your house, car, and savings—are at risk should things go wrong.
LLC: An LLC is established to protect owners from this liability, and LLC companies are considered separate entities from their members. This is especially important if you’re launching a startup that involves high liability (for example, anything related to serving food or providing experiences). If something goes wrong, the LLC will be sued instead of you (as an owner).
Are you employing staff?
Starting a business and scaling operations will potentially lead to hiring staff or onboarding business partners. There are slight differences in how this happens, depending on whether you’re running a sole proprietorship or an LLC.
Sole proprietorship: There’s no limit to how many people a sole proprietor can hire. However, the same liability applies: If something happens to one of your employees on the job, you, as sole proprietor, are personally liable for their injuries and expenses.
LLC: To hire employees, an LLC must have an Employer Identification Number (EIN), which is issued by the Internal Revenue Service (IRS) and is necessary to file tax returns and pay payroll tax. Members of an LLC are different, however, as they are considered by the IRS to be self-employed and responsible for their own taxes.
What are the tax implications?
In both LLCs and sole proprietorships, taxes are “passed through” to the business’s owners or members. This means you are responsible for filing all income and losses on your individual tax return; the business isn’t taxed separately.
Note: If you’re self-employed, you will be required to pay self-employment taxes, which cover Social Security and Medicare. There are also tax considerations that come with self-employment, including potential tax deductions related to working from home. Other business expenses might be tax deductible, too, including memberships at coworking spaces like WeWork.
Which is easier to register with your state?
Depending on your industry, you might require licenses to operate, regardless of your business structure (find out more about business licensing). However, there are different requirements for registering your business if you’re running an LLC or a sole proprietorship.
Sole proprietorship: Beyond attaining the appropriate licenses and registering a business name (more on this below), no other registration is required to operate as a sole proprietor. Your proprietorship is established automatically as you start work, and it is your responsibility to ensure that you have the correct licenses to continue operations.
LLC: An LLC needs to be registered with the state, and this happens when you file “Articles of Organization.” This document outlines the responsibilities of each member of the LLC, including their rights, powers, and obligations. As well as this, the articles should stipulate what the LLC will do for its members. The fees and rules around this registration will vary between states; in New York, for example, LLCs are required to publish a notification of their formation in two newspapers designated by the county clerk within 120 days of filing the articles.
If you’re running your LLC in more than one state, you must form the company in your “domestic” state and then file for foreign qualification in other states of operation. To do this, you should file for a Certificate of Authority with the foreign state and you may be asked to provide a Certificate of Good Standing from your home state.
A note on federal registration: Most companies don’t require federal registration. The exceptions for sole proprietorships or LLCs are if you want to trademark your business or brand with the United States Patent and Trademark Office, or if you want to register your business as a nonprofit with the IRS.
Do you need a registered business name?
Sole proprietorship: To start a sole proprietorship under your own name, you simply begin work and it will be automatically tied to you personally. To start a sole proprietorship under a company name, you must register a trademark or a Doing Business As (DBA) with your state or county clerk’s office.
LLC: To register a name as an LLC, you must search within your state to ensure no other business is operating under the same name; this search is conducted by the Secretary of State’s office. Your name will also need to include a term such as “limited company” or LLC.
Set your business up for success, regardless of business structure
For first-time entrepreneurs, building a business will bring a host of considerations much different from those that come with full- or part-time employment. As you grow your client base and hire employees, it’s helpful to have a support network of people who’ve been through similar experiences.
Coworking solutions like WeWork are ideal for this, offering a built-in community of collaborators and innovators at every office location. With a mix of entrepreneurs, startups, and established companies using WeWork, there’s no shortage of expertise whenever you’re looking for guidance.
Growing a business can open new opportunities and lead to financial success and fulfillment. Yet to be successful, it’s important to choose a business structure that affords the appropriate balance of flexibility and protection. Sole proprietorships and LLCs are popular starting points for entrepreneurs, as they offer ownership, control, and protection if you need it.
This article was originally published on November 23, 2020, and has been updated throughout by the editors.
Caitlin Bishop is a former writer for WeWork’s Ideas by WeWork, based in New York City. Previously, she was a journalist and editor at Mamamia in Sydney, Australia, and a contributing reporter at Gotham Gazette.