Choosing the right business structure has a huge impact on the financial health of your business.
The wrong structure could leave you vulnerable to lawsuits or leave you with a large tax debt, while the right structure will protect your assets and ensure steady growth.
For small business owners, the choice between an LLC, LLP, or sole proprietorship can be confusing at best. Here’s a breakdown of the three major types of small business structures, and the pros and cons of each.
What it is: A sole proprietorship means that you are an individual, independent contractor who is in business for and with yourself; the term “solopreneur” perfectly embodies this business structure. Sole proprietorships are the most popular business structure in the United States.
Pros: A sole proprietorship is easy to form and cost effective. This business structure allows you to hit the ground running – all you need to start your business is, well, some business! When your first customer makes that first purchase, a sole proprietorship is born. As long as you have any required certifications and licenses for your particular industry, you don’t even have to make any special tax considerations for your business until it’s time to file.
Cons: As a sole proprietorship, all of the costs and risks associated with your business are yours, and yours alone. Since you and your business are one entity, you are personally liable for any and all debts or legal action brought against your company, and your personal assets, such as your car, house, and bank accounts, are at risk.
What it is: A Limited Liability Corporation (sometimes called a Limited Liability Company) is a business structure that can be formed by an individual or multiple people. Unlike a sole proprietorship, an LLC differentiates between the individual and the business, offering personal protection from business liabilities.
Pros: In most states, LLCs can be formed by any professional or group looking to do business together. This means you can work with other people and pool your resources to start a business. Under an LLC, your personal assets, such as your savings and your house, are usually protected if the company is sued. It may also be easier for startups to raise capital as an LLC.
Cons: LLCs are expensive and time-consuming to start compared to sole proprietorships, and require a lot more paperwork up front. Members of an LLC may not be held personally liable for company debts, but they can be held liable for mistakes made by another member of the LLC. For instance, if one business owner defaults on a loan made to the LLC, all parties can be held responsible. Also, if an LLC is formed as an S or C corporation, it can be taxed twice on the same profits by the IRS.
What it is: A Limited Liability Partnership is similar to an LLC, but offers slightly different tax implications. In many states, LLPs can only be formed by licensed individuals like lawyers, architects, and doctors.
Pros: Unlike some LLCs, which may be double-taxed by the IRS, LLPs are treated as partnerships and offer ‘pass through’ taxation. This means that partners in the LLP are only taxed once on their personal income taxes. Another big advantage of forming an LLP is that partners are protected from one another, in that they’re not liable for the other’s mistakes. If one partner behaves badly and the LLP gets sued, the other partner can’t be held personally responsible for their actions.
Cons: This business entity is not available to everyone, and is restricted to licensed professionals only in many states.
The business structure you choose should take into consideration your industry, budget, assets, and business goals. Consider consulting a tax professional to see which structure is the best bet for your business.