Starting a small business is no easy feat. While it is an exciting time, startup founders have a lot to think about when it comes to developing a company. One of the first decisions that need to be made is what type of company structure to choose a corporation or a Limited Liability Company (LLC).
Corporations have generally been more attractive to investors for a number of reasons and startups seeking investment typically choose this structure. But in recent years, many startups have formed that don’t seek unlimited growth, or that seek alternative financing. When financing is not the central issue startups tend to choose to become an LLC. There are pros and cons to each structure, so it is important to do the due diligence to figure out which one makes the most sense.
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Benefits of an LLC
The LLC structure provides numerous benefits for startups. Aside from being simple to set up, there is also a great deal of flexibility and financial benefits. Additionally, when there are partners in a startup, an LLC offers an easy way for people to join in a mutual enterprise.
Double Taxation
In corporation structures, double taxation is an issue, while in LLC structures, it is not. Double taxation in a corporation means that both the owner and company are taxed separately. An LLC, however, is not taxed as a company. More along the lines of a sole proprietorship, the members are taxed individually on their personal income or loss from the enterprise.
Location
Delaware has been a popular state to choose for incorporation, as costs are low, and the paperwork is not as complex as other states. The cost of setting up an LLC varies from state to state. That said, many startups choose the same location where they will be working because regardless of the state the LLC is formed in, it may still have to pay taxes for operating in any other state.
Making Changes
With an LLC structure, companies do not have to worry about too much ongoing maintenance. This makes it fairly easy to add partners in the future, as well as changes or offer interests in the company to others. Making decisions to implement changes is also easier, as there is no need for a formal board process and there are not as many restrictions on administrative matters.
Protecting Assets
In the event that a startup finds itself being sued, having an LLC will prove to be beneficial. If the lawsuit is directed at the LLC, the owner’s assets are protected. This is unlike in a sole proprietorship or general partnership, where a lawsuit against the company can cost owners their personal assets.
Registering
The most notable thing about registering as an LLC is that the process itself is very easy. All state laws will have their individual differences, but as a general guide to the procedure, here’s a simple 10-step guide to forming an LLC in California that offers a good idea of what is involved. Registering with your chosen state and then applying for a Tax Identification Number with the IRS can be the end of initial paperwork for most enterprises
One thing to note, however, is that if a startup wants to change its name at some point down the line, it may be met with some difficulty. With that in mind, picking a name should be given time and much thought before registration.
There are a number of services that can set up your business for you and deal with the important steps that you need to take. Have a look at this ZenBusiness Review to see one of the newer and most highly-rated LLC formation services.
Benefits of a Corporation
While choosing an LLC structure may seem like the best idea for a startup, a C-Corp structure is still seen as the norm. There are also numerous advantages to forming a corporation, including stock options and venture capitalist (VC) preferences.
Stocks and Control
Stock is one of the biggest benefits of choosing a corporation structure. LLCs do not have stocks, although they have the ability to buy and sell stakes in the company. Stocks can carry decision-making power in a corporation, while in the LLC this power is established for each member by the Operating Agreement.
Venture Capital Prefers Corporations
VCs prefer the corporate structure to invest in. Not only because they receive stock, but some investors simply do not have the ability within their own business structure to invest in an LLC. The relationships are much simpler for VCs if the companies in their portfolio have the same structure. Additionally, investors prefer corporations because the laws and tax positions are so well-defined and bullet-proof for the investor receiving stock.
Employee Equity
With a corporation structure, a company can offer its employees equity in the business. It can easily put a certain number of stock shares aside for employees to receive at any point in the future.
An LLC can offer membership stakes to employees or new partners, but cannot subdivide company ownership unless current members give up a portion of their ownership to the potential new member. From a tax and reporting standpoint, this scenario can get complicated. Creating interests in an LLC is a tricky business, and some LLCs convert to a corporate structure to achieve further growth.
Seek Legal and Professional Advice
When it comes to making important business decisions for the future, it is always a good idea to seek legal and accounting advice. Those with extensive experience in a company’s particular industry can also provide a deeper insight into best practices when it comes to decision-making. This will give a business owner more confidence in the future of the company moving forward.
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