How to Pick the Right Entity: LLCs v. Corporations
When you create a business plan, you probably talk about finance, marketing and similar topics. But have you ever stopped to think about what kind of business entity makes sense for your new business?
There are a lot of options out there including LLCs, Corporations, Non-Profits, Partnerships, and more. LLCs and Corporations are the most popular for entrepreneurs creating for-profit companies. And in recent years, LLCs have been the favorite. But they are not always the best.
Below are a few thoughts to help you decide if an LLC is for you:
It’s easier than ever to form a business online. Most Secretaries of State allow you to form LLCs and corporations through their website and most charge a relatively small fee to do so (usually less than $200).
You might be surprised that when you form an LLC you usually don’t have to provide too much information to the state. Some states only require your business name and registered agent. Those that require more often don’t have too many more requirements.
That makes LLCs pretty attractive because when you form a corporation you often have to provide more information such as information regarding stocks, officers, directors, and more.
INTERNAL GOVERNING DOCUMENTS
Every business needs a set of governing documents. For LLCs, this usually just means an Operating Agreement. That document will outline each owner’s rights and responsibilities with respect to the company, including voting rights, economic rights, and more.
This is another factor that makes LLCs attractive because your governing documents are relatively simple. Further, LLCs are flexible. You can have different types of owners, different management structures, and you can choose how you want to be taxed.
As a comparison, corporations often have Bylaws, Shareholder Agreements, and a small number of other governing documents.
One big drawback of the LLC form is that it can’t issue stock options the same way a corporation can do so. Accordingly, if your business plan calls for stock options, you may need to consider forming a corporation instead.
You’ve probably heard about shareholders, boards of directors, officers, and the like. Those are typical of every corporation. It is owned by shareholders who elect a board of directors who hire officers (presidents, treasurers, etc.).
LLCs typically don’t have all of those roles. They usually just have owners (called members) and one or more “managers” who make decisions for the company. This is often a good thing because most new companies and most small businesses don’t want to deal with the complicated management structures in corporations. And further, if you really want a board with officers, you can always create those in your LLC’s operating agreement.
Perhaps the biggest factor you should consider is tax issues. If you form a corporation, you’ll effectively be taxed twice–once on the corporation’s profits and once when you issue dividends to shareholders. For this reason, many corporations make an “S-Corp” election to avoid the corporate-level taxes. That is often a good idea for small businesses, but it is often a bad idea for high-growth potential startups.
This is where LLC’s come into play. When you form an LLC, you get to choose how you want to be taxed. More specifically, you can choose between sole proprietor taxation, partnership taxation, S-Corp taxation, or C-Corp taxation. This is a big benefit of choosing the LLC form for your new business.
NEED MORE HELP?
If you are looking for more tips on how to structure your new business for success, consider enrolling the free FastTrac program offered by the Kauffman Foundation. Their online courses dive deeper into these issues and more. Learn more and sign up for free at www.fasttrac.org.
CONTRIBUTOR: Chris Brown, Attorney/Founder, Venture Legal