If you have a business idea, you may wish to act on it right away so you can start generating profit. However, before you do, you must form a legal entity.

Of the various types of business entities you can form, a limited liability company and sole proprietorship are best for single entrepreneurs and small startups. Before you automatically opt for one or the other, though, it is important that you understand the advantages and disadvantages of each. The Motley Fool explains the pros and cons of both an LLC and a sole proprietorship.

Limited liability company

A single-member LLC is one of the most common types of business entities, and for good reason. An LLC is an organization that shields the owner from assuming personal liability for debts that the business accrues. Also, because the IRS views LLCs as “disregarded entities,” tax liability automatically falls to the owners of LLCs.

While this may seem like a bad thing to some, it actually simplifies the tax process, thereby making it a perceived benefit to many others. Two other advantages of an LLC include its ability to separate the owner from the entity in the eyes of the law and its ability to establish the credibility of the organization quicker than if the owner had established the business as a sole proprietorship.

Single-member LLCs do come with some disadvantages, though. For instance, some states require owners of LLCs to file at both a state and county level, and to publish notice of the LLC’s formation in a local newspaper. Several other states require LLCs to file taxes periodically instead of annually. Finally, and though this may seem like a trivial manner, your business name must include “LLC” at the end.

Sole proprietorship

A sole proprietorship is the most basic type of business entity. In fact, it is so basic that you do not actually have to file any paperwork to form it; you merely have to start conducting business and collecting money for your products or services. While operating as a sole proprietor may seem easier than operating as an LLC, there are quite a few disadvantages to doing so. Those are as follows:

  • You are personally liable for the debts and obligations that your business accrues, and if you cannot cover said obligations, creditors can seize your personal property
  • You may struggle to raise money or obtain loans because many institutions do not view sole proprietors as credible
  • If you want to bring in a partner, you must restructure your business and obtain an EIN

Of course, operating as a sole proprietor is not all bad. Some advantages include the lack of start-up costs; your ability to maintain 100% control of your business; and a simplified tax-filing process. Also, if you want to dissolve your business, you need not do anything more than stop offering y our products or services.