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Choosing the right business structure is a critical decision when starting a new venture. The business structure that you choose can significantly impact key factors in your business such as exposure to liability, financing, and the rate and manner you and your business are taxed. It can also impact your ability to grow the business, the number of shareholders the business has, and the general manner in which the business is operated.
Today, we’re focusing on two of the most common structures: LLCs and corporations. There are advantages and disadvantages to each business structure and knowing what those are will help you make the best decision for your company.
Main Differences Between an LLC and Corporation
The key differences between an LLC and corporation are as follows:
- Control of Business
- Meeting Requirements
- Ownership Structure
In terms of corporations, there are essentially two types. An S-corporation and a C-corporation. Both can be more complex than a limited liability company (LLC). S-corporations are better for smaller companies with less than 100 shareholders while C-corporations can have unlimited shareholders and are best if you plan to take your company public one day. Shareholders do not directly manage the corporation, rather, they are managed by a board of directors who appoint officers to run the daily operations. S-corporation owners can get common stock while C-corporation owners can get preferred stock. C-corporations are also recognized globally, making it easier to obtain financing, funding, and capital as it is more preferred by investors.
An LLC does not require you to have a board of directors, making it to most flexible to manage and run a business when it comes to decision making. LLCs are less complex when you are just starting off a small company that you want more control over managing. LLC are taxed as a pass-through, unless otherwise elected, where as corporations pass corporate tax.
It’s also important to point out that an LLC is not a tax status. It is a state-level business structure and each state has different requirements for forming LLCs.
Main Similarities Between an LLC and Corporation
Regardless of the type of entity you chose to form, both LLCs and corporations need to be managed for the success of the business. Forming one over the other doesn’t make it any easier for the owners or people at stake. A business is a business and should be managed as such.
It’s important to stay in compliance to avoid unnecessary fees. As a business owner, it’s your responsibility to ensure these compliance matters are met. Although corporations have more rules to follow, ongoing filings are required for both LLCs and corporations. Corporations must file an article of incorporation and an LLC needs to submit an article of organization.
For each of these entity formations, the owners are not personally liable for business debts. Each has its own separate, legal identity creating a separation between ownership and company.
Entity Formation: Pros and Cons of LLC vs. Corporation
Forming a corporation is more costly, timely, and complex. You will generally need a business lawyer to help you set up a corporation, although there are several incorporation services that can also help you. Corporations require a board of directors and have more requirements and rules to follow. There are more administrative responsibilities to take care of and less flexibility in the management of a corporation because of the board of directors requirement with annual meetings and minutes needing to be taken.
An LLC has the most flexibility in management; however, an LLC cannot go public. This can mean financing for your company may be difficult if you don’t have the funds to manage the company upfront. Investors can still invest in an LLC but the process isn’t as appealing to most investors. Taxes for investors can be complicated since an LLC is a pass-through entity and requires an operating agreement. Read our full guide on how to start an LLC for more information.
Taxes: Pros and Cons of LLC vs. Corporation
LLCs are by default, taxed as a pass-through entity, meaning, the company is not taxed directly. The profits pass through to the owners who then report those earnings on their personal tax returns. An LLC is perfect for small business owners who don’t need to raise much capital from investors.
C-corporations pay corporate income tax on their profits, after offsetting income with losses, deductions, and credits. They then pay their shareholders who pay personal income taxes on the dividends they receive from the company. This results in double-taxation which is a major disadvantage of a C-corporation entity. S-corporations have pass-through taxation.
Ownership and Management: Pros and Cons of LLC vs. Corporation
Running any business takes time, knowledge, and dedication; however, if successful, it can be very rewarding. Having the correct management in place can make or break your company. An LLC has the most flexibility and control when making key management decisions because it is owned by one or a handful of people.
For a corporation, the ownership is divided across its shareholders and stockholders which can be many. Technically, anyone who owns a share of a company is considered an owner. A board of directors is required for corporations and they vote on business decisions. If you are an original owner of the corporation, you can even be voted out by the directors if you don’t hold a large enough percentage of the company. However, it’s an advantage to having other decision-makers if making decisions isn’t your strength.
Liability Protection: Pros and Cons of LLC vs. Corporation
While there is no business structure that offers absolute protection, the owners of both LLCs and corporations are all protected from personal liability. This is a huge advantage when forming any business. It’s important to keep your personal and business assets separate in case your business doesn’t succeed as planned or you get into a lawsuit so your personal assets are not exposed. Taking operational steps to reduce risk, creating company policies and workplace training can help.
Forming an LLC or corporation will not protect you from every possible risk and liability that may happen. Consider business liability insurance which covers risks your business might face. These risks include accidents and certain types of lawsuits. A basic form of liability insurance is commercial general liability insurance.
The great thing about insurance coverage is that there will be money available to defend and pay a claim. If your business is sued for a significant incident or accident, lawyers will try desperately to find someone responsible to pay, preferably a person or entity with a lot of money. If your business has very little assets or cash, the lawyer may work extra hard to bring a lawsuit against you personally if there is any possible argument for doing so. Insurance offers a possible solution with an available pool of funds.
How To Pick Which One Is Best For Your Business
Business owners who are trying to raise capital for their businesses will need to decide which entity formation is most advantageous toward their goals. Two considerations in making that decision are the source of the capital being raised and the long-term goals of the company. A C-corporation is likely the best entity for institutionally backed, high-growth companies while LLCs are likely the best entity for business owners who do not want pressure from public investors.
If you prefer to avoid double taxation and pay only personal income taxes, an LLC may be better for you. Additionally, if you want to avoid excessive formation paperwork, you may prefer an LLC. On the other hand, if you need to find as many investors as possible for your company, a C-corporation may be the better option. For more, read our article on LLC pros and cons.
The Last Word
In general, the best business structure for you will depend on many factors, and it’s best to consult a business lawyer and accountant to figure out what the best solution is for your business.
Have questions? Shoot us a note, always happy to help.
Filed under: Advice Columns