LLC vs. Sole Proprietorship: What’s the Difference?

How Do Sole Proprietorships and LLCs Differ?

The main difference between a sole proprietorship and an LLC is that an LLC protects your personal assets if your business is sued or suffers a loss. A sole proprietorship (also known as individual entrepreneurship, sole trader, or proprietorship) is an unincorporated entity owned by a single individual. It is the simplest legal form of a business entity.

What is a Sole Proprietorship?

It is the easiest and least expensive type of business structure to form, as it is an unincorporated business with one owner. If you own and operate the business on your own, you are considered a sole proprietor.

When you run a retail business, freelance, have an online business, or sell goods and services, you’re automatically a sole proprietor unless you have adopted another business structure.

In general, you can identify a sole proprietorship by the fact that the owner’s name is the business’s name, though sole proprietorships can also operate under a brand name or trade name. An important characteristic of a sole proprietorship is that there is no legal separation between the business and the owner, so the owner is personally liable for the business’s debts.

Related Article: How To Form a Sole Proprietorship

What is an LLC?

LLCs are separate, legally separate business entities created under state law. LLCs combine many of the advantages of sole proprietorships, partnerships, and corporations and offer their owners flexibility.

LLC owners decide the management structure, operating processes, and tax treatment of their business. A single-member LLC can be formed by one person, or multiple members can form a multi-member LLC.

Typically, you can identify a business as an LLC by its legal name ending in “limited liability company” or the abbreviation “LLC.” An LLC offers its members liability protection from debts and obligations of the business.

Sole Proprietorships vs. LLC: Key Differences

Formation

To form a sole proprietorship, you don’t have to do anything in particular. Perhaps you are operating a sole proprietorship without even realizing it. By default, anyone who sells goods and services without a partner is a sole proprietor. You may need a business license or zoning permit to legally operate your sole proprietorship, depending on where your business is located.

If an LLC operates under a trading name, it may also be required to file for business permits. The articles of organization are the most important formation documents for an LLC. Establishes the existence of your LLC and must be filed with the state in which you operate. There are different filing fees for different states.

Operations and Management

Since there is only one person at the top, the operation, and management structure of a sole proprietorship is simple. The owner can make any business decision they see fit, without input from anyone else.

A majority of sole proprietors hire employees, legal experts, accountants, and other experts to assist with the day-to-day management of their business. However, a sole proprietor only needs to ensure that their business is operating legally and safely and that they have enough profit to pay off all debts.

LLCs have a much more complex operational and management structure, which is typically outlined in their operating agreement.

The majority of LLCs, particularly those with multiple members, have an operating agreement, even though only a few states require it. In the operating agreement, each member specifies their ownership stake, voting rights, and profit share. The members of an LLC can collectively manage the company or an appointed manager can manage it.

Legal Protection

As a sole proprietor, there is no legal separation between the business and the owner. Business obligations are the owner’s personal responsibility. If a business fails, the sole proprietor has to file for personal bankruptcy, and both business and personal debts are included in the bankruptcy proceedings. A person who sues a sole proprietorship can also sue the owner personally and pursue their assets.

Forming an LLC is one of the best ways to protect your personal assets. Since an LLC is a separate legal entity from the owner, the owner is not liable for the business’s obligations. Owners of failing businesses can file for bankruptcy, so they don’t have to pay business creditors out of their own pockets.

With some exceptions, a person who sues an LLC cannot personally sue the owners. LLC owners can be held personally liable for fraud, negligence, or personally guaranteed debts. There is no business structure that offers absolute protection from liabilities related to the business.

Differences in Owner Control

The owner of a sole proprietorship has complete control over the business, including how it uses its profits. With a sole proprietorship, there are no other businesses or individuals to share business ideas with. It will be up to the sole proprietor to decide how to run the company and make use of the company’s resources.

Other members and managers of LLCs with more than one owner can provide input on how to run the business. Moreover, LLC owners have the option of hiring outside individuals to manage the company instead of handling its day-to-day activities themselves.

Paperwork and Compliance

The final difference between an LLC and a sole proprietorship is the paperwork and compliance requirements. A sole proprietorship requires the least amount of paperwork prior to its launch, as we discussed earlier. After launching, a sole proprietor only needs to worry about federal, state, and local taxes. A sole proprietor may also need to renew business permits.

LLCs have more compliance responsibilities. Many states require LLCs to file annual reports after filing their initial articles of organization. LLCs with multiple members have even more responsibilities, including drafting an operating agreement, issuing membership units, recording ownership transfers, and holding meetings.

It is not legally required for LLCs to take these steps, but they are highly recommended to preserve liability protection for members. Additionally, since an LLC is a registered business entity, dissolving an LLC involves additional paperwork.