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3 Big Advantages of an LLC Over a Sole Proprietorship
Regardless of whether you are starting a new business or already have one running, it might be time to decide what kind of business structure you want to move forward with. Do you want to operate a sole proprietorship or an LLC (limited liability company)?
A sole proprietorship is where you and the company are considered to be one. It is an endurable choice if you are running a low-risk business. However, it’s not such a great choice if you want to protect your personal assets and eventually grow your business.
On the other hand, an LLC is a separate entity from the business owners. It is an entity in itself and comes with a law that keeps your personal assets safe from any issues that the LLC might face. For instance, if someone sues the company and the company doesn’t have enough assets to cover the amount, your personal assets will not be considered as a payoff. Only the LLC’s assets will be used in such a case.
This is why it might be time to convert your sole proprietorship into an LLC. Need more convincing? Well, dive in to understand the concept adequately before making a decision.
What is a Sole Proprietorship?
A sole proprietorship is one of the simplest kinds of business structure. It is not a legal entity. It is one and the same as the person who owns it because it is a person doing business under their name, or doing business under a fictitious name like Sania’s Bakery. The owner of a sole proprietorship is liable for all the debts of the business and will have to pay off the creditors with everything until the debt is cleared.
To explain further, if the company is sued or has debtors to pay off, but doesn’t have enough money to do so, the owner will have to sell everything in the business to cover it. Now, let us say that this step is still not enough to cover the debt amount. In such a case, the owner will also have to sell some of their personal assets including their house, car, etc., or use their savings to pay off everything to the creditors.
In short, a sole proprietorship doesn’t offer personal liability protection (and a lot more than is explained further). That is why an LLC is a better choice.
What is an LLC?
A limited liability company (LLC) is a type of business structure that protects its owners from any personal responsibilities for its liabilities or debts. It grants its owners limited liability against any unfortunate situation. To put it in simple words, creditors cannot seize the personal assets of an LLC owner to cover up all the debt or liabilities of the business.
Due to this and the low incorporation cost, an LLC is the most considered form of business structure, after a sole proprietorship in the US. In fact, companies start off as sole proprietorships, and after a while, convert into LLCs. And the next section will explain why!
Benefits of Converting a Sole Proprietorship into an LLC
There are three main advantages of an LLC that a sole proprietorship does not have. This includes tax flexibility, limited liability, and access to more funding options to help the company grow. Let us take a look at each of these benefits in detail below:
If you open an LLC or convert your sole proprietorship into an LLC, you are in luck since LLCs come with a huge tax benefit. With an LLC, you can choose whether you want the company to be taxed as a C-corporation, S-corporation, partnership, or a single-member LLC. In fact, a lot of LLCs choose to be taxed as an S-corp since it offers a lot of tax benefits.
On the other hand, if you are a sole proprietor, you will end up paying a total of 15.3% tax on your net income. But if you are an LLC and choose to pay taxes as an S-Corp, you will only need to pay the self-employment tax on the income/salary that you pay yourself. Since you are a member of the LLC and not the company, you will have to pay yourself a salary from the company’s profits.
Moreover, in such a situation, if you can choose to pay yourself a small salary and add the rest of the amount in a Roth IRA or a Simple IRA, you save a lot in taxes. This is because these two plans are tax-deferred and will help maximize your retirement funds. Plus, it makes you pay way less tax as compared to how much you pay as a sole proprietor.
An LLC is a legal entity that is on its own and is separate from its owner, unlike the sole proprietorship which is considered to be the same entity as the owner. So, while an LLC is held accountable for all its debts, agreements, and contracts, the owner is not personally liable for any of the things that are owned by the company (which includes every loan and deal of the company).
Due to this, in case anyone sues the business, the owner will be able to protect their personal assets from the downfall of the business. Furthermore, the liability protection that an LLC offers is crucial, especially when the business has employees. This is because their actions (or mistakes) can expose your property and personal assets. And the limited liability protection is the only thing that can save it.
In fact, the protection you get in an LLC is exactly what you need if you own or are opening a high-risk business. So, even if the business becomes a defaulter or fails, it will not affect your personal possessions at all. At the end of the day, you will still have your house to go back to.
Financing Options & Business Credit
A sole proprietorship isn’t great at getting you loans and financial help from almost anywhere. And the reason behind this is simple - credibility. Moreover, if you (being a sole proprietor) at all, get approved for credit, you will end up paying really high interest rates and get into a deal where the terms are quite unfriendly. It is simply because no investor is comfortable investing in a sole proprietorship due to the high risk that comes with it and the lack of liability protection.
Out of all these options, the last one that is soundproof for a sole proprietorship is equity financing. And if you decide to take this option, you will have to end up restructuring your business. It will no longer be a sole proprietorship as you will be adding a new owner by offering them an ownership interest in exchange for financial help. Plus, to get an investor who is ready to help like this, is close to impossible.
Hence, the best way to stay ahead of all the troubles that a sole proprietorship can get you is by converting your company into an LLC. LLCs are considered credible and lenders find these structures safe. Plus, the stocks in an LLC business are versatile. It helps pave the pathway toward growing the company. You can find an investor, flaunt your LLC and make a deal where you just have to give a few shares in exchange for huge funding.
When Should You Convert Your Sole Proprietorship into an LLC?
If you are just starting your business journey, it is okay to have a sole proprietorship for a tiny bit. But the sooner you convert it into an LLC, the sooner you will be able to secure all your personal assets from any attacks made on the business. It is also a great choice to convert your business into an LLC when you are about to hire employees, add a new partner, or even raise some funds.
Moreover, converting your sole proprietorship into an LLC is inexpensive and helps you save a lot in the long run. With this said, if it is already the financial year-end, wait till next year before you convert your business to avoid paying two different tax returns (for two different business structures).