No matter the company formation experience, starting a business involves deciding which legal entity best fits that business. The two primary entity types are limited liability companies and sole proprietorships. Each offers advantages and disadvantages, so it's important to understand the differences between them and assess which is right for your business.
What is a limited liability entity and a sole proprietorship ?
A limited liability entity is a type of business structure that protects entrepreneurs who establish them from personal responsibility for their business's debts. Limited liability may also be offered to the members of companies in other legal structures, such as partnerships.
A sole proprietorship is an unincorporated business owned by one individual. The individual is assumed to be the same as the business, meaning the proprietor can be held personally liable for the actions and debts of their business.
Pros of limited liability companies
- Have separate legal status, which means the owners are not personally liable for the company's debts.
- Allows the company to have an unlimited life, meaning it doesn't need to cease to exist when a particular owner leaves the company.
- Easier to raise capital, as investors and lenders are more likely to provide funds due to the protection afforded by limited liability.
Cons of limited liability companies
- Requires a formal structure and involves ongoing maintenance requirements.
- Generally more expensive to establish and maintain than a sole proprietorship.
- Individuals’ incomes from the company are usually considered taxable income.
Pros of a sole proprietorship
- It can be a simple, inexpensive option, as there are little or no setup costs or ongoing annual filing requirements.
- The individual is the sole owner and has complete control over the business’s activities.
- Profits from the business are subject to only one layer of taxation.
Cons of a sole proprietorship
- The individual is liable for any debts the business may incur, including those incurred by employees in charge of managing the business.
- It may be difficult for sole proprietorships to raise larger sums of capital.
- The business is not considered a separate entity from the proprietor, meaning it ceases to exist if the proprietor dies, there is a change in residency, or the proprietor decides to close the business.
Considerations to weigh when making your decision
Whether you should choose a limited liability company or a sole proprietorship is largely personal. Generally, business owners should factor in liabilities, taxes, personal liability, and financial limitations when considering an entity type. Generally speaking, limited liability companies are best suited for larger businesses that are looking to protect their owners from personal liability, while sole proprietorships are better for smaller operations due to their lower costs and simpler requirements.
It is important to do your research when deciding which entity type is right for your business. Consider researching the different requirements for each entity and discussing your options with a lawyer, accountant, or another knowledgeable business advisor before making a decision.