This paper examines the key business structures available to entrepreneurs, focusing on sole proprietorships and limited liability companies (LLCs). It explains the differences in personal liability, tax treatment, operational control, and ongoing compliance requirements. The paper also addresses cash flow management and how economic factors affect business revenue, using an umbrella repair business as a practical example to illustrate the advantages of liability protection through an LLC structure.
The most common type of business structure is a sole proprietorship. A sole proprietor is simply a single individual running a business. Although it has the value of simplicity, it is important to remember that a sole proprietor is "personally liable for any business-related obligation." In other words, if the business cannot pay a fabric supplier, defaults on debt owed to the bank, or loses a lawsuit against a customer, the owner can lose his or her house or other personal possessions.
To begin a sole proprietorship, no special paperwork is required—the sole proprietor can simply begin to operate. However, he or she will need to complete necessary paperwork to hire employees, obtain legally required insurance, and work with an accountant or learn how to make business deductions on tax forms. A better option is to complete additional paperwork and open a Limited Liability Company, or LLC. The law provides owners of corporations and LLCs with what is called "limited personal liability" for business obligations. This means that, unlike sole proprietors and general partners, owners of corporations and LLCs can normally keep their house, investments, and other personal property even if their business fails.
An LLC must be registered as such, which may result in some added legal expenses. However, an LLC has a distinct advantage in terms of liability, as the owners cannot lose everything if the business fails. This seems like the better option when opening a potentially risky business—such as an umbrella repair company. Not only is the idea untested, but it is also very subject to seasonal variations. What if the weather becomes unusually dry or snowy, and people have no need for umbrellas? At least the owner will not lose all of his or her personal assets, as well as any business assets.
When running an LLC, it is essential that the owners treat the LLC as a separate business entity. If they do not, the court may find that the LLC does not "really exist" and decide "that its owners are really doing business as individuals, who are personally liable" for the losses of the business. This concept is sometimes called "piercing the corporate veil," and maintaining proper business separation is critical to preserving liability protection.
Unlike a corporation, which has many investor-owners in the form of shareholders, an LLC is not considered separate from its owners for tax purposes. Thus, the owner is not taxed twice—once upon his earnings as an individual and once on what he or she earns from the LLC. In contrast, a corporation is considered a fictive person under U.S. law, and shareholders may face double taxation.
In terms of operational control, shareholders have significant control over the operations of the corporation, while the owners of an LLC have as much control over the business as a sole proprietor would have. This flexibility, combined with liability protection and simpler tax treatment, makes the LLC structure attractive for most small business owners seeking to limit personal risk while maintaining direct operational involvement.
Cash flow, quite simply, is how much money goes in and out of the organization. Cash flow "out" includes wages, expenditures on equipment, supplies, and maintenance, and must be tracked on a monthly basis. Cash flow may vary from year to year and season to season. An umbrella repair company will likely have more money coming in if umbrellas suddenly become fashionable or if the weather grows extremely windy or rainy.
The macro economy will also affect revenue. Depending on how the company markets itself to consumers, it might show stronger earnings if people are losing their jobs and carefully managing their savings. Conversely, if it markets itself as a luxury operation repairing expensive designer umbrellas, people may find it cheaper to buy a new umbrella than to have an older one repaired. Tracking cash flow is essential for producing the product, because it may take time to show a profit and will certainly take time to generate enough revenue from customers to cover overhead expenses.
For an uncertain venture like umbrella repair, the liability protection of an LLC outweighs the additional paperwork and legal expenses required to establish one. By choosing an LLC structure, entrepreneurs can test new business ideas while protecting their personal assets from the risks inherent in any new venture.
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