Have your entrepreneurial inspirations motivated you to run a business? If so, you are likely trying to decide if you want to incorporate or operate as a self-employed individual. But, believe it or not, these two are not the same. Instead, their business models work differently in several important ways, dramatically impacting how you run your company.
If you’re stuck trying to determine the best option when starting up, this guide is for you!
What Does it Mean to Be Self-Employed or a Business Owner?
In business, two of the most common interchanged terms are “self-employed” and “business owner.” The difference between these concepts relies on the application more than the meaning. Technically, if you’re a business owner, you are also self-employed. But, not everyone who is self-employed is a business owner—confused yet?
Essentially, you are a small business owner if you hire employees or independent contractors to help run your company. On the other hand, if you are your own boss, you are self-employed.
Those who own companies choose an entity formation to incorporate, such as a limited liability company (LLC). This step highlights how a self-employed person does not go through this process because they act as sole-proprietorship. All related business management duties, risks, benefits, income, and taxation pass through them directly.
Pros and Cons of Being an LLC or Sole Proprietorship
Any entity formation you choose to run a business under has advantages and drawbacks. To get a better idea of what you’re signing up for when choosing an LLC or Sole Proprietorship structure, a few pros and cons are below:
Pros and Cons of a Sole Proprietorship
Right off the bat, you enjoy minimal start-up costs when launching a business as a sole proprietor. Typically, there aren’t any filing fees, annual reporting requirements, operating agreements, or hiring of a registered agent. In addition to low upfront investment, income gets reported on your personal tax return.
With these budget-friendly advantages, there are some serious risks too. For example, your personal assets could be put on the chopping block if you fall behind on your debts because your business can’t afford them. This includes if someone gets hurt because of your services or products and decides to sue you for personal injury damages. It’s also challenging to acquire funding for a sole-proprietorship since you can’t share ownership interest. Lenders may view your business as a high-risk investment and say no.
Pros and Cons of an LLC
One of the most popular reasons small business owners rely on an LLC structure is to safeguard their personal assets from business-related liabilities. The possible tax savings can’t be ignored either since there are different types of limited liability formations to choose from. You can file as a partnership, single-owner, S or C-corporation, and more!
As incredible as this sounds, start-up filing fees can get pricey depending on your incorporated state. Every year a renewal fee is due to the Secretary of State. In addition, you will need to hire someone to act as your registered agent. Entrepreneurs with limited funds may find this challenging to afford. In addition to formation expenses, LLCs sometimes have to pay additional local and state taxes.
Cost of Forming Your Business as an LLC or Sole Proprietorship
A sole proprietorship is the default entity structure for anyone operating a business. No filing is necessary since this is automatic. For example, you’re a sole proprietor when you accept payment and ship out that product or pressure wash a customer’s fence.
Those who opt to form an LLC model immediately will pay for any required state filing fees, including the costs of all required licensing and permits to operate. In addition, most states require limited liability companies to submit an Operating Agreement and an Articles of Organization. These documents outline how your business gets managed, by whom, and what ownership stake all members have.
The price to set up an LLC varies by state, with some starting as low as a hundred dollars. However, you also have to remain compliant and submit an annual report to your Secretary of State to maintain good standing.
Self-employed individuals never worry about this additional responsibility because they are the only member of their company who has ownership.
What Liability Insurance do LLCs and Self-employed Businesses Need?
One thing that both LLCs and sole proprietorships should always have is insurance! Without it, the fallout from expensive lawsuit settlements, business interruptions, and dangerous climate events can leave your company financially devastated. A comprehensive Business Owner’s Policy can address many of your company’s daily risks.
Not sure options you have to choose from when creating a BOP? Below are the four most commonly bought commercial insurance policies and how they protect your business:
One of the most important coverages you can purchase for your business is general liability coverage. It will protect your company against a wide variety of claims that could involve:
- Property damage
- Bodily injury
- Libel claims
- Copyright Infringement
- Intellectual property theft
This coverage only applies to third-party claims and not those of your employees. If you have a customer or other company sue for any of the above, your policy will cover the costs of defending your claim and cover ordered damage settlements.
Also referred to as Errors and Omissions (E&) coverage, a professional liability policy addresses claims against your company alleging financial losses. This insurance protects a variety of professional services, including accountants, attorneys, doctors, and more.
Some of the common scenarios that you would need this coverage for include:
- Negligence (purposeful harm caused to a third party)
- Financial loss caused by your services/advice
- Mistakes and omissions you make
- Not fulfilling the services you agreed to perform
Business Owners Policy (BOP)
This policy option is a bundle of several coverages into one. Many businesses choose this insurance to provide the most comprehensive liability protection possible. Often, these packages offer a better price than purchasing each coverage separately.
Standard BOP packages often include many of the following:
- General liability
- Business interruption
- Commercial property
- Professional liability
- Commercial auto
- Workers’ Compensation
- Cyber protection
- Hired and non-owned auto
Commercial insurance for self-employed individuals can offer effective defense against liability situations that threaten your financial stability. LLCs should also take getting insurance seriously since their business structure only prevents personal assets from being used to settle claims.
Who’s The Winner: LLCs or Self-Employed?
Believe it or not, both can be when you’ve just opened for business. A sole proprietorship gives you much more flexibility and control of how you’ll run your company in the beginning. You won’t have high start-up costs related to paperwork or registration, so you can focus on growing.
An LLC model is an excellent option once you are ready to expand and add more members to your entity. Costs are relatively low to set one up compared to corporations and partnerships, and you still get significant tax breaks. Plus, your personal assets are separate from your company, so you never have to worry about creditors coming after your private checking.