You’ve refined the perfect idea for a startup, you’ve chosen your partners carefully, and you’ve defined a supply and distribution chain to get your product developed and out to market; your company is ready to start operating, right? First you have to actually legally create your company, and that involves a big decision: whether your company will be structured as a corporation or a limited liability company (LLC).
So what are the differences between the two, and how can you decide which format will be most beneficial for your startup? We’ll discuss the basics of both LLCs and corporations, and give you the information you need to select the best option for your startup company.
What to know about corporations
There are several configurations of corporations available, but the most popular is the C-corporation which is a type of corporation that is taxed independently from its owners. One of the major differences between a corporation and an LLC is that corporations can issue stock.
Stocks offer two advantages: they allow the corporation to confer certain decision-making powers as needed, and they make it simple to distribute the equity of the company over a larger pool of owners.
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Typically, venture capitalists investing in companies insist that they be organized as corporations because of the ability to issue stock, but there are plenty of other reasons why choosing to establish your startup as an LLC will more than offset this.
LLCs and income taxes
Double taxation is an issue that arises for owners of corporations, because both the corporate entity and the owners of stock are taxed independently, the one on its revenues, and the others on their dividends. This amounts to double taxation on the same money.
In an LLC, on the other hand, revenues (or losses) of the business flow through directly to the members of the company, who report their gains or losses from the company on their individual tax returns, and are therefore only taxed once. For many budding entrepreneurs, this is one of the most significant benefits of choosing an LLC over a corporation.
Other advantages that LLCs offer to startups
Although there are some distinct features of a corporation that you don’t get with an LLC, such as stock options, on the whole LLCs offer a more diverse array of benefits, including the following.
You can select a location to establish your LLC
Just like when you are incorporating, the law allows you to establish your LLC in any state that you wish, even if you don’t operate there. The main benefit to this is that some states are known for having historically business-friendly laws and courts that are well-equipped to handle corporate litigation cases.
Delaware is one notable example, which is why you’ve probably noticed many companies listed as established in Delaware even if the founders aren’t from there. Note that the fees associated with setting up an LLC will vary from state to state. Additionally, your LLC is required to pay taxes in the state in which it is established, and the state(s) where it operates.
Change your LLC with little hassle
LLCs enjoy fewer restrictions than their C-corporation counterparts, including when changes need to be made to the structure of the company. In short, LLCs give owners enhanced freedom to make decisions quickly and easily, such as changing roles and duties or amending the structural framework of the leadership. It’s even fairly simple to convert your LLC to a corporation if you decide to do so later on.
Establish an LLC quickly
Choose a state you want to register in, fill out a modest amount of paperwork, pay the generally reasonable fees assessed by the state, and your LLC is ready to go. As soon as the quick process is completed you can hit the ground running and enjoy all of the protections under the law that establishing an LLC allows.
For a breakdown of the steps, see this guide to forming an LLC in California. The procedures will be similar in all states.
Ensure your assets are protected and reduce personal risk
One of the biggest concerns that many entrepreneurs have when they establish a startup company is what will happen to their personal wealth in the event that things don’t go as planned. The term “limited liability” is at the heart of LLC, meaning that the structure offers asset protection to members listed on the company filing.
If your LLC is subject to a lawsuit or some bankruptcy proceedings, then apart from exceptional circumstance, the lawsuit can’t reach to the personal assets of the owners. This is the same protection a corporation offers, but with additional flexibility.
Use losses to offset personal income
LLCs offer another less-known benefit to owners in the form of pass-through of losses. This stipulates that tax benefits such as deductions, losses, and credits can be used to offset an LLC member’s personal earned income.
This is especially helpful early in a company’s lifespan when high product development, marketing, and R&D costs often force startups to operate at significant losses. And because of its flexible operating agreement that specifies interests and duties, the LLC can be attractive to silent investors who don’t want to work in the company.
Most startups can benefit from registering as LLCs
It’s clear that LLCs offer distinct advantages to many different kinds of startups, especially those that aren’t aiming for boundless growth projections that necessitate massive VC contributions.
When deciding on the structure of your company it’s important to examine every possibility, so be sure to secure expert legal advice before filing your paperwork if you have any questions concerning which type is right for you and your partners.