Startups throughout the country are faced with countless decisions. However, one of the questions that startups must answer during the early days regards the company structure: should it be a Limited Liability Company (LLC) or a Corporation. Whether you choose to form an LLC in California, or prefer the added tax benefits of Texas, one thing is certain, state laws will impact your decision. Fortunately, the following insights will help you to select the right choice for your growing organization.
LLC: The Preferred Choice to Avoid Double Taxation
The beauty of the LLC is that it helps startup business owners avoid double taxation. Double taxation can occur when a start-up chooses to use a Corporation structure. This structure ensures that the company and owner are taxed separately, which can lead to increased payments come tax time. The LLC structure, by contrast, means that startups are taxed more like a sole proprietorship. The LLC structure is especially beneficial in states, like Texas, that have no state income tax. Of course, if needed, startups can always convert to a Corporation later on.
Corporations: The Good, the Bad, and the Ugly
Venture Capital companies often prefer a corporation structure for one simple reason: stocks. In fact, the potential for a stock structure is arguably the only reason that a startup would choose a Corporation business structure over an LLC. LLCs don’t have stocks. Instead, they have “membership stakes” that can act like stocks without creating separate classes. LLC membership stakes are independent of the decision-making powers of members, which is created through the LLC’s Operating Agreement.
In a C-Corporation, investors can create preferred shares of stock, which carry different decision-making powers. Additionally, it is far easier to calculate and distribute equity within a Corporation. This means that startups can set aside shares of stock for future distribution. The latter option isn’t available in an LLC, where membership constitutes 100 percent of the LLC from the beginning. The moral of the story when it comes to stocks is that Corporations have the upper hand; but that’s where the buck stops.
LLCs Offer More Benefits than Corporations
Stock options aside, LLCs offer startups a wider plethora of benefits than Corporations. These potential benefits include:
1. Startups can choose the location of the LLC
As with a corporation, you can choose where to establish your LLC. For example, you might want to consider Delaware, which is a historically pro-business state. Keep in mind that the cost of setting up the LLC will depend on state regulations. Additionally, you will have to pay the taxes for the state where your LLC was formed, as well as the state where you operate. In other words, if you operate in New York, but are hoping to enjoy the tax benefits of Texas, then you might find yourself subject to filing taxes in both Texas and New York. If you become confused by the wide number of choices, you can always ask a professional for help weighing the pros and cons of each state.
2. Startups can easily make changes to the LLC
Unlike a C-Corporation, an LLC doesn’t require a lot of continual maintenance or keeping minutes of decisions. Adding new members is a fairly straightforward process. There are also fewer restrictions, which means that startups can focus on completing high-priority tasks rather than becoming bogged down by their chosen business structure. The LLC business structure also gives owners more choices about how they run, operate and structure their business. This freedom is especially helpful for growing startups.
3. It is easy and fast to set-up an LLC
Setting up an LLC is typically a quick, easy, and simple process that doesn’t require hefty registration fees or paperwork. Once you have successfully registered the LLC in your chosen state, the IRS will issue an Employer ID Number (EID), you will be able to open business bank accounts, and you will immediately enjoy all of the legal protections that the LLC offers startups.
4. Assets are protected
The LLC structure helps startup business owners protect their personal assets. In fact, the LLC creates a separation between business and personal assets. In layman’s terms, if a lawsuit is filed against the startup or one of the members, then the LLC will prevent the prosecutor from going after your personal assets.
5. Pass-through of losses
Losses, credits, deductions, and any other tax benefit items can pass through to an LLC member’s individual tax returns. In other words, the LLC’s losses can be used to offset other earned income, which is just another tax benefit of the LLC business structure.
With all of the above benefits in mind, there is one word of caution. Changing the name of an LLC is a cumbersome and challenging process, which is why startups need to carefully choose the name for their LLC.
The Bottom Line: Startups Prefer the Protection of an LLC
The membership and governance flexibility, tax benefits and asset protection of the LLC are just a few of the reasons that it is the preferred business structure for startups. Additionally, startups can easily switch from an LLC to a corporation, once they have grown their business and are interested in offering stock options or hardening the protections.
Ultimately, a legal professional can help startups decide which business structure is the ideal choice for their new, established or growing startup. And if you’re already decided, both the attorney and online incorporation service route can get your company off the ground quickly. Just be sure it’s the proper choice for you.