KYB requirements for sole proprietorships vs. LLCs
Limited liability companies (LLCs) and sole proprietorships are among the most common and accessible business structures, but they differ in key areas like ownership, taxation, and liability.
These structural differences impact how each entity should be verified. If your company regularly works with LLCs or sole proprietorships, understanding how to properly vet them is essential.
Read on to explore how these business types compare, their respective advantages and disadvantages, and what their differences mean for your KYB process.
What is an LLC? What is a sole proprietorship?
A limited liability company (LLC) is a business entity that offers business owners personal liability protection. This means if an LLC defaults on a loan or gets hit with a lawsuit, the business owner’s personal assets (like their home) aren’t in jeopardy.
LLCs can have one or more business owners, called members. Multiple-member LLCs create operating agreements that outline the company’s management structure and each member’s ownership share.
A sole proprietorship is a business structure in which one person owns the business and there’s no legal separation between the owner and the entity. This means the sole proprietor’s personal and business assets are considered one and the same, so there’s no personal liability protection.
What’s the difference between an LLC and a sole proprietorship?
Here’s a summary of some key differences between LLCs and sole proprietorships, though it’s not an exhaustive list:
| LLC | Sole proprietorship |
Structure | LLCs can be single-member (with one owner) or multi-member (with more than one owner). | The sole proprietor is the only business owner. |
Setup | LLCs are pretty easy to form; you just have to follow your state guidelines for incorporating and filling out paperwork. | There’s no paperwork or formal registration required to become a sole proprietor. However, if a sole proprietor chooses to use a “Doing Business As” (DBA) name, they need to register with the Secretary of State. |
Taxes | LLCs are classified as pass-through entities, so their profits aren’t taxed at the business level like corporations. Instead, earnings flow directly to the individual members, who report and pay federal income taxes on their personal returns. Single-member LLCs file using an individual tax return, while multi-member LLCs typically file as partnerships. That said, some LLCs can choose to be taxed as an S-corporation or C-corporation, depending on their needs. | The sole proprietor reports their business’s profits and losses on their personal income tax return. |
Liability | LLCs offer limited liability protection, meaning members’ personal assets are generally shielded if the business faces financial trouble. | Sole proprietorships have unlimited liability, meaning the owner is personally responsible for the business’s assets and liabilities. |
Types | Small businesses, usually with one to 10 employees | Independent contractors, consultants, freelancers, gig workers, and small businesses |
Advantages and disadvantages of LLCs
LLCs are attractive because they’re simple to set up, offer structural flexibility, and provide legal separation between personal and business finances. LLCs also benefit from pass-through taxation, helping them avoid the double taxation common to corporations. Plus, LLCs typically find it easier to secure funding than sole proprietors.
However, since LLC members are treated as self-employed for tax purposes, they’re responsible for paying Social Security and Medicare taxes out of pocket.
Advantages and disadvantages of sole proprietorships
The main benefit of operating as a sole proprietorship is the low barrier to entry: sole proprietors don’t need to do anything to register or file their business unless they want to operate under a DBA name. What’s more, as the sole owner, they have total control and autonomy over their business decisions.
On the downside, sole proprietors take on full personal liability for their business finances, which can be risky. They also face challenges scaling, especially when it comes to hiring and accessing capital.
How KYB differs for LLCs vs sole proprietorships
If your company works with other businesses, it’s critical to have a Know Your Business (KYB) strategy in place. Setting up a KYB process can help you meet anti-money laundering (AML) and other compliance requirements, prevent fraud, and ensure you're equipped to handle higher-risk entities.
Here’s how the KYB process works for LLCs versus sole proprietorships.
KYB for LLCs
Performing KYB on LLCs involves two key steps: 1) verifying the business’s identity and 2) verifying the people behind the business, or its ultimate beneficial owners (UBOs). This includes anyone who owns a significant part of the company — usually 25% or more.
If an LLC has multiple members, you may need to verify multiple UBOs. Here are the general KYB steps:
Verify the LLC: Collect the business’s name, proof of registration, operating address, and employer identification number (EIN), and verify these details against official government databases to confirm the business’s legitimacy.
Verify the UBO(s): Gather each LLC member’s name, date of birth, and address, then use government ID verification or database verification to confirm their identities.
Perform additional AML checks as needed: You might also need to do a PEP check, sanctions screening, or adverse media screening for enhanced due diligence (EDD).
KYB/C for sole proprietorships
Because sole proprietorships have a simple ownership structure where the business isn’t separate from the business owner, you can use a standard Know Your Customer (KYC) process to verify them. That includes the following steps:
Verify the sole proprietor’s identity: Using government ID verification or database verification, verify their personal details, including their name, date of birth, and address.
Perform additional AML checks: Run a sanctions screening, PEP check, or adverse media screening depending on what your risk assessment indicates.
Streamlining the KYB process with Persona
No matter which types of businesses you work with, Persona can help you perform KYB quickly and thoroughly.
Dynamic Flow lets you build custom flows that make it easy for new customers to declare whether they’re an LLC or sole proprietor, then upload the necessary documentation to get verified. And Persona’s flexible KYB-KYC platform checks UBO information against dozens of authoritative databases, lets individuals choose their preferred IDV method, and allows you to set up automated monitoring and reverifications at trigger points.
Learn more about Persona’s KYB solution or reach out for a demo today.
