One of the first decisions entrepreneurs need to take when starting a business is deciding on the right business structure. One of the most common options is the sole proprietorship, a simple but effective type of business model. Although many new business owners choose this type of structure for its simple plan of setup, it is important to know and understand how it stacks up when compared to other business forms, especially liability, taxation, and flexibility.
In this article, we look at sole proprietorships and compare them to other similar business structures, such as partnerships, limited liability companies (LLCs) and corporations. You’ll end up with a clearer idea of the business model that is ideal for your entrepreneurial objective.
What Is a Sole Proprietorship?
A sole proprietorship is the most basic type of business entity, with one individual owning and running the business. All decisions and day-to-day operations are handled by the owner. More importantly, there is no legal separation between the owner and the business entity.
This entity is also often easy to start, being low-cost, and requiring no formal registration (in many jurisdictions). The owner pays all profits and is personally responsible for all debts and any lawsuits a business may enter into.
Similar Business Structures
Sole proprietorships are common, but other business structures come with unique benefits and challenges given business owners’ goals. Here’s a run through of business models that are “like” sole proprietorships regarding ownership and management but differ in significant ways.
1. Partnerships
Unlike a sole proprietorship, a partnership is formed by two or more people. Similar to a sole proprietorship, a partnership is relatively easy to form and manage flexibly. A general partnership means all partners can also share in its responsibility for operations, profits, and liabilities.
- Resemblance to Sole Proprietorship: In both cases the owner(s) have direct control and these entities commonly do not result in large paperwork or fees to establish.
- Key Differences: A partnership is a shared ownership arrangement where profits and decision-making are divided among the partners. Also, every partner is personally liable for the partnership’s obligations, akin to the liability risk in a sole proprietorship.
2. Limited Liabilty Companies (LLCs)
An LLC provides more protection than a sole proprietorship but still gives you flexibility of structure. Members, or owners, of an LLC are not personally liable for the debts and liabilities of the business, in contrast to a sole proprietor.
- Comparisons to Sole Proprietorship: An LLC has similar pass-through taxation as a sole proprietorship, meaning the profits would be taxed on the owner’s personal tax return. LLCs can also be a single member (single-owner LLC) business, and it functions similar to a sole proprietorship.
- Key Differences———————The key difference is liability protection. Unlike sole proprietors, LLC owners have limited liability protecting their personal assets from business debts. Plus, forming an LLC usually requires more paperwork and fees than a sole proprietorship.
3. Corporations (C-Corp and S-Corp)
C-corps and S-corps, also legal entities separate from their owners. Corporations provide a more complicated structure than sole proprietorships and generally cater to larger companies or those looking for investment.
- Similarities to Sole Proprietorship: A sole owner can own both a C-corp and an S-corp (although these business structures are usually structured for multiple owners). Either type of business can offer tax advantages for certain businesses.
- Key Differences: The main difference is that corporations are separate legal entities, which means that they protect against personal liability for business debts. Moreover, the differences range from increased regulatory requirement for corporations, higher start-up costs and more complex tax filings than sole proprietorship.
4. Sole Proprietorship vs. S-Corp
An S-Corp is a tax classification for a corporation or LLC that allows for pass-through taxation in a similar manner as a sole proprietor. A sole proprietorship can be easy, but an S-Corporation may help you save money and provide personal liability protection.
- Similarities to Sole Proprietorship: As pass-through entities, both also avoid “double taxation” as a C-corp would experience. In a way, a sole proprietor may choose to have their business taxed as an S-corp in some cases.
- Why This Matters: Unlike a sole proprietorship, an S-corp requires formalities like annual meetings and record keeping. S-corps also have a limit on the number of shareholders and other limitations on ownership.
What Structure is Best for You?
The best business structure type for you will depend on your business goals, risk tolerance, and how much complexity you’re willing to deal with.
- If you are new to entrepreneurship and you are looking for an easy, low-cost way to run a business, then a sole proprietorship may be the best option.
- If you want personal liability protection and you’re willing to file a little more paperwork, an LLC might be a good choice.
- If your company is growing, courting investors or expanding into more nuanced management, a corporation may be more advantageous.
- If you want to share the responsibilities, risks and rewards, a partnership is right for you.
Conclusion
A sole proprietorship is a great fit for many small businesses because it’s simple and requires few administrative tasks, but it’s not the best choice for every entrepreneur. When making this business decision, your understanding of business structures that are “like a” sole proprietorship but provide varying degrees of liability protection, tax implications, and management flexibility is critical as you form this entity. Carefully consider your personal goals, business needs, and risk tolerance before committing to a structure that can support your success.
