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.
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.
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.
As with anything in the financial space, there are pros and cons with sole proprietorship. Benefits can include:
As for possible drawbacks, those include:
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.”
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.
When assessing LLC vs. sole proprietorship, note that there are also benefits and drawbacks to LLCs. On the plus side, LLCs offer:
Disadvantages could include:
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.
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.
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.
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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.
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