Choosing a legal structure is one of the first and most important decisions a business owner will make, and there are a number of different options to choose from. Many new businesses start as sole proprietorships or general partnerships because they are simple to create. However, that simplicity comes with significant risk.

Below is a brief overview of how these two common structures work and why a Limited Liability Company (LLC) is often a better long-term choice.

1. Sole Proprietorship: This is the most basic form of business where the business and the owner are legally the same. You don’t need to file any registration documents with the Secretary of State, though you might choose to register a simple tradename, and you don’t need a business EIN.

   Disadvantages: While the simplicity of a sole proprietorship can be appealing, the biggest disadvantage is there is no legal separation between the business and the owner. This means if you’re the owner:

   i. Business debts are your personal debts;

   ii. Lawsuits against the business can reach your personal assets; and

   iii. Unexpected accidents or contract disputes can put your personal property at risk.

   While it is easy and inexpensive to start, the lack of liability protection makes this structure risky for most operating businesses.

2. General Partnership: A general partnership is similar to a sole proprietorship, except it is formed when two or more people agree to conduct business together without forming any legal entity Profits, losses, and business decisions are all shared among the partners. Like a sole proprietorship, business income is reported on the partners’ personal tax returns.

   Disadvantages: A general partnership carries many of the same risks as a sole proprietorship, but multiplied:

   i. Each partner is personally liable for all debts;

   ii. Liability is typically joint and several, meaning a creditor can pursue any partner individually for the entire obligation; and

   iii. A partner can be held legally and financially responsible for actions taken by another partner within the course of business.

   In other words, your personal assets may be at risk not only because of your own decisions, but also because of your partner’s actions.

3. Limited Liability Company: An LLC can be formed by one person, or multiple people, and requires registration with the Secretary of State and annual reporting. It’s a few extra steps when compared to sole proprietorships and partnerships, but the benefits are often worth it.

   Advantages:

   i. Unlike sole proprietorships and partnerships, an LLC creates a separate legal entity distinct from its owners (referred to as members), meaning your personal property is generally protected from judgments and creditors if the LLC faces financial difficulties and is unable to pay its debts;

   ii. Similar to sole proprietorships and general partnerships, LLCs are considered “pass-through entities.” The profits and losses “pass through” to the individual members’ tax returns; and

   iii. LLCs can be flexible and typically require less rigid governance and recordkeeping than a corporation, for example. A good operating agreement can outline ownership structure, management rights, and profit and loss sharing for your LLC.

   Ultimately, an LLC provides the simplicity many small businesses want, without exposing personal assets to significant risk.

Conclusion: Sole proprietorships and general partnerships are easy to start, but they expose owners to substantial personal liability. While there are several other business structures to choose from, forming an LLC offers a more balanced approach as to liability protection, tax flexibility, and operational simplicity for most people.

Before launching your business, it’s worth taking the time to choose the right structure. A small investment in proper formation at the beginning can prevent major legal and financial consequences down the road.