Trading can be a risky business by its very nature. Thankfully, there are plenty of practical ways in which traders can mitigate and control their risk. One of the most impactful steps of all is to choose the right legal bulwark.
For most traders, this boils down to a simple choice between two options: Establishing your business as a Sole Proprietorship or establishing it as a Limited Liability Company (or LLC).
While both options have their pros and cons, most traders find the LLC format to be more advantageous on the whole. Here’s a quick explanation as to why.
LLCs and Sole Proprietorships: Defining the Terms
Both of these options represent legal structures that are widely available to business owners, including traders. Here’s a quick rundown of each.
Sole Proprietorships, Explained
A Sole Proprietorship is generally considered to be the simplest option for business owners. It’s basically an unincorporated business structure that involves a single owner. In fact, if you’re running your own business without any additional personnel or staff, you’re considered by default to be a Sole Proprietor.
The main characteristic of the Sole Proprietorship is that there is no legal demarcation between the business and the owner. In other words, you’re not creating a new legal entity; you are the business, and vice versa. This is why most Sole Proprietorships simply operate under the owner’s name, though operating under a brand name can be an option.
When you trade via a Sole Proprietorship, then, all of your business assets are yours… but business losses and liabilities are yours, too.
LLCs, Explained
By contrast, consider the LLC. Though this format is slightly more complicated and expensive than the Sole Proprietorship, it is actually the most popular small business structure in the country. Entrepreneurs love LLCs because there is a ton of flexibility, not just in terms of how you manage the business but also how you report to the IRS. And, there are some important personal liability protections, which is what distinguishes this structure from the Sole Proprietorship.
To that end, when you launch an LLC, you’re creating a whole new entity, thus making a clean break between you and your company. As such, an LLC allows you to keep your business assets/liabilities separate from your personal assets/liabilities.
The upshot of this is that, when you have an LLC, your personal assets (for example, your family’s bank account) can be kept completely shielded from lawsuits and from creditors. This is just the kind of peace of mind that many traders crave.
LLCs and Sole Proprietorships: Comparing the Two Options
While it’s important to do your due diligence, exploring the relative merits of both business structures, most traders will find the LLC path to be the best bet. There are a number of reasons for this. To understand them better, consider a few critical points of comparison.
Formation
When it comes to forming your business, the Sole Proprietorship is certainly the easier option. All you need to do is get a business permit (if your state requires one), and to register any trade names you want to use.
Forming an LLC is a little bit tougher, yet it’s still pretty minimal in its administrative burden. Generally speaking, the steps required include choosing a business name, registering your Articles of Organization with the state, paying a nominal LLC fee, obtaining an EIN from the Internal Revenue Service, and starting a business bank account. While the fees can vary, in many states you can launch an LLC for under $100 total.
Be aware that the steps for forming an LLC can fluctuate a little bit from state to state, and it’s always important to review state-specific guidelines. For instance, here is a guide to forming an LLC in Wyoming.
Operation and Management
By definition, a Sole Proprietorship has one owner who makes all the decisions.
LLCs, on the other hand, provide a lot of built-in flexibility with regard to how you run the company. When you launch an LLC, you have the chance to draft your own Operating Agreement, which outlines how managerial duties will be allocated. You can run the business yourself, bring in partners, or even outsource day-to-day administration to an external management company.
Taxes
Taxation is another area where the LLC structure offers traders just a bit more wiggle room.
Sole Proprietorships are always taxed on a pass-through basis. While this is the default option for LLCs, as well, the LLC owner can elect to be taxed on a corporate basis, if that proves to be more advantageous.
Legal Protections
Here’s where we really get into the main advantages of the LLC. When you’re a Sole Proprietor, you assume all business profits, but also all business liabilities and debts. In other words, you’re personally on the hook for creditors and lawsuits. But with an LLC, you can keep your personal assets out of the business altogether, ensuring that the courts cannot seize, say, your family’s house, or your retirement account.
Reporting
Finally, note that the paperwork and compliance element is pretty simple for both types of business structures. Sole Proprietors just need to pay their taxes and keep their business permits current. LLCs may have some minimal reporting requirements, which can vary by state, and must also pay a small LLC renewal fee each year, but these obligations are minor.
For Traders, the LLC is the Best Option
The bottom line: Traders incur a healthy amount of risk. For most traders, the single best way to mediate this risk is by structuring your business as an LLC, taking full advantage of the personal liability protections that it offers.
Author Bio
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about digital and social media marketing. Drawing from a robust background in journalism and copywriting, she frequently writes about topics related to business ownership and LLC formation.
