Business Startups: Should I do business as a sole proprietor or form an LLC?
Before diving into the world of entrepreneurship and starting Toews Digital, we had a very surface level knowledge of the legal language that goes along with the business world. And as we discussed these thoughts with other entrepreneurs, it was interesting to find out that we were not alone in this lack of knowledge! We had questions like…
Here’s the thing: it’s common to not know!
So we sat down with our attorney, Ryan C. Davis Law, PLLC, to break down the major differences between a sole proprietorship and an LLC.
To start, here are a few definitions...
Sole Proprietorship A business that is owned and managed by one individual, with no legal structure separate from its owner. The owner, called a sole proprietor, does not pay separate income tax on the company, but reports all losses and profits on his/her individual tax return. Because the owner is indistinguishable from the business, he/she remains personally liable for all debts of the business (source).
In English Please… A Sole Proprietorship is just one person who owns and operates their business by themselves, pays taxes as an individual and is personally responsible for the debts and liabilities of the business.
Limited Liability Company (LLC) A type of business entity that offers the limited liability of a corporation and can choose to be taxed as either a sole proprietorship or a corporation. The owners of an LLC are referred to as "members," whose rights and responsibilities in managing the LLC are governed by an operating agreement. An LLC can be formed with only one owner/member. However, it’s important to understand that a single-member LLC offers less protection from the debts and liabilities of a business than a multi-member LLC. This is known as “piercing the corporate veil,” and can get a little complicated. Nonetheless, even a single-member LLC provides more protection for its owner than a sole proprietorship. An LLC is legally formed by the filing of a document called the articles of organization with a state official, usually the Secretary of State (source).
In English Please… An LLC is a type of business that has legal protection and potential tax benefits. Owners (aka members) should create an operating agreement (especially if you have more than one member). You’ll form the LLC by filing some basic paperwork with your state (and pay a fee, which is $300ish in TN).
I’m not doing anything illegal, do I really need an LLC?
No one ever thinks they are going to be sued, but do you remember the customer who sued McDonald’s for getting hot coffee spilled on her? Crazy things happen. What it boils down to is... if you are a sole proprietor and someone sues your business, they might be able to get to your personal assets. And (here’s an important part) vice versa. If you are in a car wreck and someone sues YOU and you don’t have enough money to pay, they can take money from your business or even take ownership of it until they are paid back. Because as a sole proprietor, you ARE your business. The other protection an LLC provides is from creditors. If a business has no LLC or corporation protection and has debts it can’t afford to pay, those lenders can get to your personal assets to satisfy those debts. With an LLC, however, those personal assets are typically shielded from creditors. However, it is important to note that some lenders may require a single-member LLC that lacks credit worthiness to make personal guarantees, thus opening up one’s personal assets to liability to those lenders.
Simply put, an LLC separates and protects your personal assets from your business assets and… your business assets from your personal.
But the one thing you must NOT do as an LLC is…
Commingle funds. Meaning, you MUST have a separate bank account set up that handles your businesses transactions and ONLY your businesses transactions. Ryan said this is the #1 mistake he sees clients do and it renders your LLC virtually useless. When you mix personal transactions with your business transactions, you make it easier for someone suing you to “pierce the corporate veil” and it opens the door to you being personally responsible for debts and liabilities of the business. So before you grab that non-business coffee on the company card, don’t. And when you’re mobile scanning that check into your bank account, MAKE SURE that it’s going into the correct account.
3 Questions To Ask Before Forming an LLC
Do I REALLY need one? Set up a meeting with an attorney AND an accountant to figure out if this is a good move for your business from a legal and tax perspective.
Is this business more than an idea? A lot of people rush into setting up an LLC because they have a great idea but then never follow through. Do the research and make a business plan first! In the end, think about the work that goes into it as well as the costs, and don’t let all of that all to go to waste.
Am I doing this just to “claim” my business name? Believe it or not a lot of people do this. And forming an LLC does NOT stop someone else from using that same name for their marketing purposes. It’s not the same thing as a trademark.
We’ve barely scratched the surface on the subject of forming an LLC and everything you should know or consider before doing so, but we hope this helps answer some of of those exploratory questions! Our main piece of advice would be to start the conversation with an attorney to get the best insight for your particular business.
If you’re in the state of Tennessee and are interested in forming your own LLC, we highly recommend using Ryan C. Davis Law, PLLC for your business (and any other) legal needs! Beyond setting up business entities, Ryan also works in criminal and family law and would be happy to help you!.
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