Should My Startup Be Structured as a Corporation or a Limited Liability Company (LLC)?
One of the first big legal decisions that entrepreneurs make when staring a business is selecting the appropriate legal entity for their business. The two most popular options are a corporation and a limited liability corporation (LLC). So, what’s best structure for your business? As with many decisions, the answer is that it depends on the circumstances and goals of your particular business. The two key differences between a corporation and an LLC are the ability to divide ownership and the way in which their income is taxed. Here is an overview of the pros and cons of corporations and LLCs to help you make a decision.
PROS AND CONS OF LIMITED LIABILITY COMPANIES (LLCS)
An LLC is a great choice for many small businesses because it is easy to setup and maintain and provides the same liability protection as a corporation.
Pros
An LLC is easy to setup.
An LLC provides the same protection against personal liability of the owners as a corporation.
An LLC isn’t subject to many of bureaucratic requirements of a corporation — you don’t have to hold an annual shareholder meeting, record meeting minutes, create a board of directors, document important decisions, etc.
An LLC doesn’t have shares like a corporation. Instead, you define who the members are and what percentage of the business each member owns.
An LLC is taxed as a pass-through entity where the profits and losses of the business are passed through to the owners’ personal tax returns, thus avoiding the same profits being taxed twice (once for the business and again when distributed to the owners).
Cons
An LLC does not allow for separate classes of membership. Thus, all membership stakes are given the same rights and decision-making power.
Most venture capitalists (VCs), accelerator programs and incubators strongly prefer or require preferred shares of stock, which isn’t possible with an LLC.
An LLC requires that 100% of the membership interests be owned at all times, which is difficult if you are interested in giving your current or future employees an equity interest in the business as part of their compensation. In order to give equity to someone new, an existing member of the LLC must sell some of their membership interest to the new member.
PROS AND CONS OF CORPORATIONS
A corporation is typically the preferred entity choice for startups who plan to receive VC funding, participate in accelerator or incubator programs, or offer equity interests to current and future employees as part of their compensation package.
Pros
A corporation can have separate classes of stock, such as preferred shares of stock, which is strongly preferred or required by most venture capitalists (VCs), accelerator programs, and incubators.
A corporation allows you to offer your current and future employees equity in the business because you can set aside shares of stock that can be distributed to employees at a later time.
Cons
A corporation has more formal requirements and maintenance obligations than an LLC, such as holding an annual shareholder meeting, recording meeting minutes, creating a board of directors, and formally documenting important decisions.
Corporations are subject to “double taxation” — the corporation is a tax-paying entity that pays taxes on its profits, and the shareholders are then taxed again on those profits as personal income when they are distributed. Note that there is an option to declare a corporation as an “S-Corporation” instead of a “C-Corporation” for tax purposes, which eliminates the “double taxation issue” and flows through the profits and losses to the shareholders much like an LLC. However, there are several restrictions for qualifies for S Corporation treatment, including that your investors need to be individuals (i.e. not a VC other company) and residents of the U.S.