Limited Liability Company Vs Sole Proprietorship

While there are many different kinds of business entities from which to choose from including S Corporations and Non-Profit organizations, the to most often chosen for entrepreneurs are a Limited Liability Company or Sole Proprietorship. These two types may be similar in some aspects but their differences can play an important role in how a business operates and how it affects the individual both legally and financially. We will examine these differences and hopefully help you make an informed decision of which type of business is appropriate for you.

A limited liability company, also known as LLC, is a recent advancement in business formation and it has become very popular in the last 10 years. What made it popular is that it is easy to form and operates in a similar fashion to a sole proprietorship but provides additional legal protection. Sole proprietorships on the other hand have been around forever and are frequently used by many individuals because the essentially treat all business operations as the person using their Social Security Number and bank account. As you can tell from that definition, a sole proprietorship is the least secure and can expose individuals to lawsuits and other legal complications.

Legal Protection

The primary determining factor of why an individual would choose an LLC over a sole proprietorship is that of legal protection. There are essentially no other substantial differences from using the LLC for your business. In reality no one should use a sole proprietorship and the creation of an LLC should have happened a long time ago. Sole proprietorships treat the individual owner and the operation as one in the same. That means all money and property are legally at risk should the owner face a lawsuit from business operations.

This obviously places sole proprietorships at a significant disadvantage especially in certain industries. Limited liability companies on the other hand treat the business and the owner as separate entities which offers the same protection that corporations are normally the only ones privy to having. Should something go wrong and a customer is injured financially or physically then an LLC may limit the lawsuit to only the business and prevent personal assets from becoming seized. Of course there are many different types of injuries that can befall a customer and legal protection is not absolute but it's better than nothing which is what is available in a sole proprietorship.

Credit and Operations

Most businesses require some sort of credit or other form of financing to conduct business operations. When forming a sole proprietorship, most bank accounts and credit cards are opened under Doing Business As or DBAs. Since a sole proprietor and the owner are the same entity any credit received such as short-term loans or credit cards will be legally tied to the individual. A common statistic is that 75% of all small businesses fail within the first year so any accumulated debt could ruin an individual's credit under a sole proprietorship. A limited liability company maintains a separate entity status for credit similar to what it does for legal liability. This can help protect an individual's credit rating from being ruined should an unforeseen calamity caused the business to fail.

One of the only drawbacks to a limited liability company is the fact it isn't as easy to establish as a sole proprietorship. This make sense considering it will be a legally recognized separate entity by the state so it should require some effort on the individuals part. This effort normally entails filling out a limited liability company application and presenting a fee to register with the State Corporation commission. If there is more than one party or you're not comfortable with filling out the paperwork it is recommended you seek the advice of legal counsel and have them draw up the documents and submit them to the state. Regardless of this requirement it is a small price to pay to protect yourself legally and financially from business operations.

Summary

It may not seem like there are any significant differences between a limited liability company versus a sole proprietorship but the differences that do exist can be instrumental in protecting yourself. Business decisions, similar to medical decisions, should never be made on their own and always taken to a professional. Besides the marginal cost and minor inconvenience of some paperwork an LLC will often be the correct decision for many individuals who would've normally formed a sole proprietorship. Legal implications and credit considerations are both important enough factors that an LLC will be the right decision in most cases.