Small Business LLC Vs. Corporation Vs. Sole Proprietorship

by John Cromwell

    When starting a business, one of the first and most important decisions you can make is what type of organization your business should take. Three popular choices are sole proprietorship, corporation and limited liability company. It is important to note that a business organizes subject to the law of the state where it is based. As a result, the legal requirements and processes may vary. When organizing a business, consider obtaining professional help or using an online third party document provider to ensure that you complete all required filings correctly.

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    Factors to Consider

    Before choosing a business form, you should consider factors like the type of industry you are entering and the types of legal and financial liabilities the business may generate. You should also consider the trajectory you want your business to take. If your plan is to keep your business small, you will probably want to organize your business differently than if you want to position your business to be bought out or go public. Finally, you should consider the regulatory requirements and costs to set up and maintain each business.

    Sole Proprietorship

    A sole proprietorship is a business with one owner who has complete discretion regarding decision-making for the business. This type of business is not a separate legal entity from its owner. This means the owner is personally liable for all of the business’s liabilities and legal obligations. Also, all of the business’s income and expenses are included on the owner’s tax return. There are very few requirements to organizing a sole proprietorship; once a person undertakes a business on his own, he is automatically in a sole proprietorship without having to file anything with a government entity. It is important to note that a sole proprietorship can have employees but it cannot have more than one owner. This limits a sole proprietorship’s ability to gain investors.

    Limited Liability Company

    An LLC is a legal entity that is separate from its owners, who are known as members. This means that in most cases, the owners are not personally liable for the business’s liabilities and legal obligations. The members are taxed on their share of the business’s annual income and losses. LLCs can have multiple members. Depending on how the entity is structured, the business can be run by all of the members or by chosen representatives. However, most LLCs restrict the ability of its members to transfer their ownership shares to others. This limits the ability of LLCs to raise investment. The business also has to apply to become an LLC in the state where it is located, and submit annual reports and pay annual fees. LLCs tend to work better with medium sized companies where there is not a lot of transfer of ownership.

    Corporations

    A corporation is also a distinct legal entity that protects the owners from being personally liable for the business’s financial and legal obligations. However, a corporation’s income is taxed twice. When the income is earned, the corporation pays taxes on it. Then, if it issues a dividend, the shareholders pay taxes on what they receive. The day-to-day decisions regarding the business are generally made by appointed officers, with broader strategic decisions being made by a board of directors. The shareholders’ participation in the business is generally limited to appointing the directors and voting on larger decisions, such as whether to terminate the company. A business must apply to the state to form a corporation, and is generally required to file annual reports and pay an annual fee. Corporation stock generally can be sold easily, which is good for businesses that want to generate investment to aggressively grow.

    About the Author

    John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.