Sometimes when you start a business and it begins to take off; you can be overwhelmed by how quickly everything begins to roll. Before you know it, you can be signing deals, moving products and making money in the blink of an eye. (If you’re felling a little unorganized, read this.) All of that is exciting but it can sometimes mean you haven?t covered all of your legal bases.
Though entrepreneurs usually have a great grip on the law (and sometimes even have legal counsel on staff) when it comes to handling liability, protecting personal assets and remaining compliant with the state, there are other issues like operating agreements and website privacy policies that can go unnoticed and add up to a whole lot of trouble if they?re not taken care of. The law is a revolving process that needs to be maintained and groomed throughout your business life.
I know the law isn?t always cut and dry so I sought out advice from trusted counsel to help get my own legal matters in order. I was lucky to talk with the dynamic group of ladies behind the law firm, Smith, Shapourian and Mignano LLP, an all-female practice in San Francisco, California that helps small businesses understand their legal requirements. They helped me gain a legal perspective on some important law issues we all need to be considering as entrepreneurs. That’s why I’ve taken the opportunity to bring you a new series on important law perspectives for entrepreneurs like yourself. For the first part of the series, we’ll be looking at the two different types of businesses and which one is the right choice for you.
Sole Proprietorship vs. LLC
The first step to getting your legal life on par is to figure out whether your business operates as a sole proprietorship or as a limited liability company, known as an LLC. Both are easy to setup as long as you know the state?s requirements. (Thinking about rebranding? Act fast before you pick a business name!) In this particular state, you would look at the regulations set up by the California Secretary of State?s Office.
Smith, Shapourian and Mignano LLP say the process to set up a sole proprietorship goes like this:
- Choose a business name available for use, after performing a federal and state name search
- File a Fictitious Business Name Statement with the appropriate county recorder
- Obtain licenses, permits, and zoning clearance, if applicable
- Obtain an Employer Identification Number
The process to set up an LLC is similar but there are a few additional steps that you need to be aware of.
Setting up your business as an LLC is likewise relatively simple and straightforward, especially for single-member LLCs. In California, you must register your LLC with the California Secretary of State?s office by filing Articles of Organization.
While you?re forming your LLC, you?ll also need to do the following:
- Choose a business name available for use, after performing a federal and state name search
- Draft an Operating Agreement tailored to the single-member or multi-member California LLC
- Prepare an initial Statement of Information for filing within 90 days of formation of the LLC
- Obtain licenses, permits, and zoning clearance
- Obtain an Employer Identification Number
- If you have been operating as a sole proprietorship prior to forming an LLC, draft a Founder IP Assignment Agreement (for assignment of your domain and website, existing trademarks, patents etc.), or a Transfer of Assets and Liabilities Agreement, if there are more assets to transfer from your sole proprietorship to your LLC (such as a commercial lease, insurance policy, capital, etc.)
The ladies also say that if two or more people are in charge of the LLC, that you?ll want to make sure you have an operating agreement to distinguish duties. They also say that though there are more fees associated with setting up an LLC, the benefits can be worth the upfront investment. In fact, when choosing your business name, a main component to think about is that by choosing to name your business a sole proprietorship, you do not offer yourself any protection from being held responsible on an individual level.
Unlike a sole proprietor or general partner in a partnership, an LLC owner is not personally liable for the business liabilities or debts of the LLC. While an LLC owner may forfeit his or her capital contribution to the business if the LLC fails, an LLC owner is not personally liable for the LLC?s debts or legal liabilities. So, the LLC owner?s personal assets, such as his or her home, car, or individual bank account, are not at risk.
Just be aware that in almost all cases there are exceptions to this rule, like if you haven?t paid your taxes or took out personal guarantees on your loan. When it comes to taxes, the two different types of businesses, sole proprietorship or LLC, have similar tax processes. Check out the Small Business Administration to learn more.
For federal tax purposes, there is not much difference between organizing your business as a sole proprietorship versus an LLC. A sole proprietor?s income is taxed on an individual income tax return. LLCs receive ?pass through? treatment, which similarly allow allocated profits to be taxed on each member?s individual income tax return. In California, however, there is a minimum annual franchise tax of $800, which is due shortly after forming an LLC.
When it comes to profit sharing, an LLC may be the way you want to go, especially if you have more than one business owner.
An LLC provides owners with a flexible structure to determine how profits are allocated under the applicable Operating Agreement. LLC members are not necessarily limited to their proportion of ownership, and may agree to divide up profits in a different manner. However, LLC?s may not distribute profits when it endangers solvency, or when liabilities are equal to or greater than assets.
So what do the fees really breakdown to when talking about choosing a sole proprietorship vs. LLC and which one has the best features? Let’s take a closer look.
Though the differences in a sole proprietorship and an LLC can be slight, the right move for your business can be a personal and important choice. If you need help figuring out a business plan that works for you, reach out to a trained professional to help you make your next move.
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