LLC or Schedule C? Which is Better?

I get this question a lot. I know there are plenty of people out there who will tell you that you don’t need an LLC right away when you start a business, but I respectfully disagree.

I’m absolutely not a fan of Schedule C. I think they are often a lawsuit waiting to happen, and I think owners of Schedule C businesses are often unaware of just how much danger they are in.

There are 3 key reasons I feel this way.

Reason #1 Liability

Here’s the thing. With a Schedule C business, there is no separation between you the person and you the business. It doesn’t matter if you have a separate bank account. It doesn’t matter if you have a Fictitious Business Name or DBA on file, and that you always do business as Carla’s Cupcake Creations. It doesn’t matter that you keep separate accounting records. All that matters to the law is your legal structure. And you have none. That means the business debts are your debts. The business problems are your problems, and the business lawsuits are your lawsuits. If you have partners, then your problems have doubled, because anything your partner does is also your problem, and vice-versa.

When you are sued personally and have a judgment made against you, pretty much anything goes when it comes to collecting it. The other side can look to your house, car, savings accounts, kids college funds, and so on.

Moving into a business structure, like a corporation or an LLC can change that. That’s because the law views a business structure as a separate legal person. If the business structure is sued, you as the owner are not necessarily taken along for the ride. Unless you have personally guaranteed a debt of the business, or have used the business structure for illegal activities, generally all you can lose is what you’ve invested into the business. And if you think about it – it’s much easier to rebuild your business than it is to rebuild your entire life.

Reason #2: Independent Business Credit

Liability is just Reason #1. If that’s not enough to sway you, here are two more reasons

1. A business structure lets you build independent business credit and
2. A Business Structure lets you sell your business for its true value

Schedule C business owners aren’t able to establish independent business credit. Because you have no legal separation between you and the business, there is no way to separate you from the business when it comes to obtaining credit, either.

But when you move into a legal business structure you can begin the process of separating yourself. That means getting credit which is NOT subject to your personal guarantee. This is something many business owners don’t even know that they can do! But you can. It takes some work, and costs you a bit to do a few things, however at the end of the day you can often build a much higher business line of credit independent of your personal guarantee than you can WITH a personal guarantee.

Reason #3: Business Undervaluation

The third reason I don’t like Schedule C’s is that you can’t value them properly. Because the business is so inextricably linked to you, the person, when it comes to selling the business it will automatically be discounted by business brokers and other business owners. You don’t have a business to sell really – and you can’t sell yourself. So what you’re left with is selling your goodwill and maybe a client list. That can mean something you spent a lifetime building with the goal of passing it on to your children isn’t worth what you thought, at the end of the day.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

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