Why To Skip the Sole Proprietorship and Form an LLC

  • By John Scharbach
  • Published 1/25/2016

Traditionally, American small business owners had only three options to organize their business:

  • a partnership (limited or general)
  • an S corporation
  • a sole proprietorship

All three were “disregarded” for tax purposes (meaning they were not subject to a separate and additional layer of taxes), which is a big plus for small business owners. But each also had its limitations. Partnerships were ill-suited for single owners and lacked some of the more robust liability protections. S Corporations avoided those problems, but were organizationally cumbersome. Sole proprietorships were organizationally simple, but lacked any of the liability protection.

Then, in 1977, a new business model was created by a Wyoming oil company: the limited liability company. This new LLC was designed to be a hybrid of the best of all three entities: it was flexible, granted limitations on liability, and disregarded for tax purposes. By the turn of the century, Wyoming-style LLCs had been blessed by the IRS and were fast becoming a small-business staple.

The reason for the explosive growth of LLCs is simple: they are in almost every case the best organizational structure for small businesses. LLCs are:

  • quick to set up
  • easy to maintain
  • have minimal tax consequences
  • grant you liability limitation
  • establish a legal division between your personal and business finances
  • allow you to sell equity and bring on new owners

And they do all this while being organizationally simple and flexible.

Obviously, “nothing in life is absolute, except vodka.” There are a variety of ticky-tacky reasons why you should consider another organizational form. The most prominent is that you plan to have a lot of owners (i.e. hundreds), and want to be able to easily manage and sell stock, in which case you should probably form a corporation.

But except for a few rare circumstances, there is no persuasive reason for most small businesses to use any structure besides an LLC.

More than that, LLCs are unquestionably superior to a sole proprietorship. All those “LLC vs. sole proprietorship” articles on the Internet are just empty words. If you don’t mind spending a few hundred dollars on filing fees and an hour of an attorney’s time, then as an objective business matter, a properly formed LLC is superior to a sole proprietorship. Period.

So if you’re running a sole proprietorship, do yourself a favor and…

  1. Stop whatever you are doing
  2. Find a good general business attorney
  3. Say you want to form an LLC
  4. Get the process started

Go get it, small business owner! We believe in you.

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