If you own your business as an individual and have not formed an entity such as an LLC or corporation, you are what’s called a sole proprietorship. Sole proprietorships have a few perks, but they also come with risks.
The most obvious perk of remaining a sole proprietorship is the simplicity of administrative tasks. Formal business entities must file documents with the Secretary of State every other year. They also typically hold annual meetings where minutes are taken. Sole proprietorships, on the other hand, need not worry about these responsibilities and can focus 100% of their energy into running the business. It also saves a few dollars in filing fees.
The main risk that comes with a sole proprietorship is that the owner personally assumes liability for the business. If an individual or other business entity sues and wins a judgment against a sole proprietorship, the owner would be expected to use all of his or her assets — both business and personal, in order to satisfy the judgment. Likewise, if the sole proprietorship incurs debt, the owner is held personally liable to its creditors.
LLC stands for Limited Liability Company. The owners of an LLC can only be held liable for an amount up to the total amount of money each invested into the LLC. Contrast this with sole proprietorships — in a similar situation, all of the owner’s assets are in play.
LLCs are a popular choice for small business owners because they insulate the owners from liability without an overwhelming amount of formalities. They also avoid the double taxation that comes with operating as a corporation. LLCs can have one member or many members. By using an Operating Agreement, the owner or owners can adjust the rules that govern the LLC as needed.
We often recommend the use of LLCs to our small business clients since the benefits tend to outweigh the negative aspects. If a business owner forms an LLC then later deems it unnecessary, dissolving the LLC is fairly straightforward. Of course, every business is different and owners should carefully consider all options with their professional advisors before making a decision to form a formal business entity.