What to Know About Sole Proprietorship vs LLC

Key Takeaways

• The chief characteristic of LLCs is member protection from the business’s debts and obligations.

• Compared to other business types, a sole proprietorship is the simplest to form.

•  LLC owners can decide how they want management structured and how their taxes will be set up.

Investors interested in venture capital funds should understand limited liability companies (LLCs) as well as sole proprietorships. While there are similarities between the two business structures, there are also important distinctions. 

Here is what to know about sole proprietorship vs. LLC.

What is Sole Proprietorship?

When it comes to sole proprietorship vs LLC, the former is an unincorporated business entity with one owner.

Because of the entity’s simple structure, a person who runs a business independently is automatically the sole proprietor. If an individual operates an online business or as a freelancer, for example, they are the sole proprietor by default. That is, unless they have a different type of business formation.

Legally, sole proprietors are personally liable for the business’s debts. Also, the proprietor’s name is generally also the name of the business. However, the business can also operate under a trade or brand name.

Note that despite their “sole” status, most such proprietors ultimately bring aboard employees, attorneys, accountants, and other professionals.

How Do You Start a Sole Proprietorship?

Compared to other business types, a sole proprietorship is the least expensive to form. It is also the easiest.

In fact, there is nothing specific one necessarily must do to establish a sole proprietorship. If a person is operating a business by themselves, they could have a sole proprietorship and not even know it.

Having said that, local governments may require zoning or business licensure for proprietorship operation. Also, any type of business operating under a trade name must gain a “doing business as,” or DBA, certificate.

What are the Pros and Cons of Sole Proprietorship?

As with anything in the financial space, there are pros and cons with sole proprietorship. Benefits can include:

• Easy formation and low cost.
• No annual filings or reports.
• No corporate business taxes.
• Unrestricted by formal business structure.
• East recordkeeping.

As for possible drawbacks, those include:

• Unlimited liability.
• Challenges raising money.
• Self-employment taxes on all earnings.
• Inability to handle business debt.
• Can be viewed as less than professional.

What is LLC?

Legally, a limited liability company is a separate business entity that is established under state law.

This type of structure combines aspects of a partnership and corporation, as well as a proprietorship. An individual may establish a single-member LLC, or multiple people can put together a multi-member LLC.

LLC owners can decide how they want management structured and how their taxes will be set up. They also can decide how operational processes will look.

The chief characteristic of LLCs is member protection from the business’s debts and obligations. If there is a business creditor lawsuit, for example, the owners need not worry about losing personal assets.

The legal name for a limited liability company will usually end with “LLC.”

How Do You Start an LLC?

In addition to a likely DBA and business licenses, LLCs must have what are called articles of organization. This important document establishes the LLCs existence and must be filed in the state where the business operates. The cost ranges from $50 to $200, depending on the state.

What are the Pros and Cons of an LLC?

When assessing LLC vs. sole proprietorship, note that there are also benefits and drawbacks to LLCs. On the plus side, LLCs offer:

• Flexible management structure. 
• Flow-through taxation.
• Limited liability protection.
• Separate legal identity.

Disadvantages could include:

• Possible dissolution if a member departs.
• Costs relatively more to fund and maintain.
• Potential loss of limited liability
• Challenges obtaining investors. 

How are LLC and Sole Proprietorship Similar and Different?

In LLC vs sole proprietorship, members of LLCs are shielded from the company’s debts. With sole proprietorship, the owner is liable for all obligations. If the business becomes bankrupt, for example, the owner must file for personal bankruptcy. The court will include personal as well as business debt in proceedings.

And with one person on top, a sole proprietorship has a relatively simpler operational and management structure. Also, the owner here is free to make all decisions, with no third-party input. They must only ensure safe and legal business operation, and they have sufficient profit for debt coverage.

By contrast, an LLC has a more complex make-up that is usually contained in an operating agreement. The document covers the business ownership stake of each member, in addition to profit share and voting rights. There may be an appointed manager, or the LLC may be collectively managed. 

In sole proprietorship vs. LLC, the two have similar tax treatments, at least for single-member LLCs. Both business types are pass-through entities, which means that the business itself pays no income taxes. Rather, the owner reports business income which gets taxed at their personal rate. 

With multi-member LLCs, business tax returns must be filed with the IRS. Also, each member must report. their share of the business’s income. There may be a business or franchise tax, depending on the state.

Both LLCs and sole proprietorships may have to pay payroll taxes if there are employees. There also may be state and local taxes if goods or services are sold. That is in addition to self-employment taxes.

Note that only LLCs can opt to stay with pass-through taxation or elect corporate tax status, which could save money.

Regarding paperwork, a sole proprietorship calls for the least amount. In addition to keeping up with taxes, the sole proprietor may have to renew business licenses. For LLCs, there are more compliance obligations, often including an annual report. A multi-member LLC may have to craft an operating agreement, record transfers of ownership, and issue membership units.

Which Should You Use Based on Your Business Goals?

Sole proprietorship vs LLC. That’s what it comes down to. Many companies begin as sole proprietors due to the relatively simple set up and tax treatment. 

Such status can become fraught, though, when, or if, the business expands. With sole proprietorship, there is no legal protection for one’s personal assets if the business fails or falters. More protection is offered through LLCs. In addition, LLCs provide more tax flexibility, as they can opt for corporate tax status.

Thus, choosing the best business structure hinges on a number of factors that should be carefully considered, perhaps with a business attorney.

How to Invest in Venture Capital 

Sole proprietorships and LLs relate to venture capital funds. Such funds comprise pooled investment capital managed for investors who seek private equity in startups with strong growth prospects.

The leading alternative investment platform Yieldstreet offers ways to invest in early-stage companies with venture capital funds. Its venture capital program offers retail investors exposure to sector-disrupting private companies, or companies creating whole new sectors. It is during these stages that companies usually undergo rapid growth as commercialization gears up and allows for scale.

Investing in private markets also serves another essential purpose – portfolio diversification. Constructing a portfolio with a mix of asset types with varying anticipated performances is key to overall risk mitigation.

Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary 

When it comes to sole proprietorship vs LLC, there are major differences in terms of structure, legal protection, and taxes. Whether investing in venture capital funds or starting a business, understanding the two entities is paramount.