Among the most important of many serious decisions that any startup owner will have to make is should the company be structured as a limited liability company (LLC) or a corporation? Let’s examine the advantages and drawbacks of each type, and provide you with the insight you need in order to set your company up for success.
Benefits offered by an LLC
The major benefits of establishing your startup as an LLC instead of a corporation include increased flexibility, ease of process, and nuanced asset protection. For multiple partners who are looking to create a venture together, the structure of an LLC makes it simple and straightforward to get the business off the ground. For some concrete examples, see this guide to creating an LLC in California.
Double taxation refers to the government levying taxes both on a business and on the owner of that business as separate levies. The structure of a corporation allows this to happen, but when you establish as an LLC, it is not taxed the same way a corporation is. Instead, each member listed in the LLC operating agreement is taxed on each member’s personal gains or losses from the business, much as would be done for a sole proprietorship.
As with a corporation, when you establish an LLC you can choose to create it in any state you would like, even if you have no plans of doing business there. Some states, such as Delaware, feature lower initial costs and simpler paperwork, and are therefore more attractive to many startup owners. However, it’s important to know that you are required to pay taxes in the state in which you establish your LLC, even if you don’t earn a single cent of revenue from there.
Making changes to an LLC
Creating an LLC gives you remarkable freedom to make changes to the structure of the company on the fly, which can be vital to a company in the early stages of its life cycle. If you need to add partners or make other significant changes you can do so quickly and easily, without the need for formal board approval that comes with a corporate structure.
As far as the LLC registration process itself, it is typically simple in most states, even though each state will have its own unique process. Once you complete your state’s forms and pay the fees, you can apply to receive an IRS Tax Identification Number, and then your business is ready to begin operating. The only change that is difficult to make with an LLC is changing the name, so you will want to settle on something that works for you for the long-term before filing.
Protecting member assets
If your LLC is the subject of a lawsuit, it is only the LLC that is being sued, not you personally. That means that except in specific instances, your personal assets can’t be a part of the court award, only your contribution into the LLC. Compare this to a sole proprietorship, where the personal assets of the owner are fair game if the company should be sued. In short, establishing your company as an LLC can protect everything you and your family have worked for.
Benefits offered by a corporation
Corporations have many advantages also, however, and there are a few distinct ways that they differentiate themselves from the LLC structure, such as in the following.
Corporations can issue shares of stock, which represent a value of equity and can also confer decision-making power. Stock can easily split and subdivide into lesser fractions of the whole. This is one of the main differences between a corporation and an LLC. An LLC can add new partners and give them elements of control, but not by reducing the existing membership interests of other members. It can get complicated to achieve this in an LLC, and you will sometimes see a startup LLC convert into a corporation in order to scale up.
Venture capital investment
Because it’s so easy to issue shares of stock in a corporate structure, many venture capitalists are drawn to invest in companies that register as corporations. They can easily receive shares of equity for their investment, and it’s generally seen as simpler for a VC firm to invest in companies bound by this structure. Also, tax laws are generally seen as more favorable for investors who are investing in corporations.
Once again, the corporate structure makes it very easy to distribute equity via stock, and this includes for employees of the company as well. Owners can issue shares designated for employee stock incentives and have them available for the future, offering an additional perk to draw coveted candidates to a startup. And while the LLC can accommodate the silent investor because the ownership interest and the duties can be separated through the operating agreement, types of stock in a corporation can confer or withhold this control very simply.
Making an important decision about your company’s future
Ultimately, you will have to weigh the pros and cons of each structure to determine the best course of action for your company. If you need a steady influx of VC cash in the early going, then a corporation might be necessary. But, if you prefer enhanced flexibility and tax benefits you should consider an LLC more carefully. Before making any decision with this many ramifications for the future of your business, it’s always best to seek legal advice from someone with extensive experience in business law. They can help you examine your specific needs and circumstances, and give you the confidence you need to make the best decision for you and your stakeholders.