Do you have a solid business idea, but you are unsure which legal structure will best carry your business forward into the future?
One of the biggest decisions that you will face when starting your company is whether you will form a Limited Liability Company (LLC), a C-corporation (C-corp) or an S-corporation (S-corp). Choosing the right entity structure from the start will help make sure your company is set up for success now and into the future.
When speaking to entrepreneurs and founders, I have noticed two issues that come up all the time. First, many people are misinformed about which type of entity structure is best for their business. And, second, they do not take the time to dig in to understand how each type of entity will affect the success of their business.
In the video below, I provide an overview of several important considerations to help you narrow your choices when deciding what type of entity to set up for Your Great Business.
3 Key Considerations: LLC vs. Corporation
1. Money: LLC vs. Corporation – Consider future financing and investment opportunities when determining
Seed Financings and Friends & Family Rounds:
- C-corp: Gives you the most flexibility because there are not restrictions on the number or type of stockholders that C-corps may have. Investors are familiar with the corporate form, as well as the financing documents and terms that are typically used in Seed and Friends & Family financings.
- S-corp: Functions the same as a C-corp, however, is limited to the type and number of stockholders allowed. For example. S-corp stockholders must be individuals and U.S. citizens.
- LLC: If you start to take on more than a few investors, the operating agreement and LLC structure can become complicated and costly to put in place.
Venture Capital Financings:
- C-corp: Generally the best option given the familiarity of this structure among VC’s.
- S-corp: For tax purposes, it may make sense to form an S-corp initially. Down the road, you can convert the S-corp to a C-corp when the time is right.
- LLC: This form may not work given the possible tax restrictions that VC’s may have.
- C-corp: Once Equity Crowd-Funding is allowed under the securities laws, the C-corp will provide the best form to take advantage of this new frontier in raising money. C-corps are built to have a lot of shareholders, a perpetual existence, and they provide for easy ownership transfer of shares.
- S-corp: Because the S-corp is limited to 100 stockholders, it may keep your company from taking full advantage of Equity Crowd-Funding.
- LLC: As mentioned above, it is often complicated and costly to add ownership interests to an existing LLC structure.
2. People – Provide equity incentives to motivate and retain employees:
Grant incentive stock options or restricted stock to your employees to give them a piece of the company’s equity ownership so that they are motivated to advance the company.
- C-corp: The best option for providing tax-favorable incentive stock option grants to employees. Also, a C-corp may set up multiple classes of stock (i.e., preferred stock and common stock) and grant stock or options to employees at different classes.
- S-corp: Although you may grant incentive stock options to employees, S-corps are only allowed to have one class of stock and you may not be able to structure your option pricing in a way that would distinguish the company’s preferred and common stock.
- LLC: Putting an LLC ownership incentive plan in place is often difficult and expensive.
3. Possible Exit Opportunities:
Consider possible exit strategies now so that you can take advantage of them in the future.
- C-corp: Offers a great tax advantages over other entity forms. If your C-corp’s stock qualifies as “Qualified Small Business Stock” and you have held it for more than five years, then you may have significantly lower capital gains taxes down the road when you sell your stock or company.
- S-corp: Because the S-corp is a pass-through entity for tax purposes, the Qualified Small Business Stock tax incentives currently do not apply to S-corps.
- LLC: Like the S-corp, LLCs do not qualify for the Qualified Small Business Stock tax incentives.
Other startup issues to consider when comparing a LLC vs. Corporation:
- Limited Liability Protection:
- Each form of legal entity will provide you with limited liability protection.
- LLC: considered the most flexible entity type when it comes to structure and set up because the owners may allocate profits and losses to different investors or owners via a customized operating agreement. However, with customization and complexity, there will also be more costs.
- Corporations: tried and true and provide predictability and familiarity.
- Simplicity and Lower Costs:
- Corporations: Because the corporate form is familiar and well-known, setting one up tends to be simpler and less costly.
- LLC: Costs tend to rise as LLCs add more members and owners.
- Flow-through Taxation:
- Corporations: Unlike flow-through entities, c-corps are taxed at the corporate level and again at the stockholder level. However, to avoid double-taxation, the corporation may elect to be taxed as an S-corp.
- LLC: Profits and losses flow through to the LLC’s owners and members, and LLC does not pay taxes at the entity level.