LLC Versus Corporation Versus Partnership Versus….
Choosing the right business structure for your new business can be tough. Should you incorporate? Should you create an LLC? Or is a sole proprietorship or a partnership good enough for now? Starting a new business is daunting enough just on the business side; figuring out the best way to structure and organize your business can easily dampen enthusiasm and delay development if you don’t know where to begin. When I interview new clients about their business formation needs, I start with a series of simple questions. Believe it or not, identifying the right type of entity for your business can be quick and easy if you know the right questions to ask.
This post isn’t intended to take the place of a consultation with an experienced business attorney, but having an idea of the direction you want to go can help inform and expedite the process of forming your business when you do sit down with your lawyer.
How many people are involved in your business?
This question might seem simplistic, but it’s one that I ask every business client when we sit down to discuss creating a new business entity. Before you even get to LLC versus corporation, or this structure versus that one, ask who the people involved are and how they relate to each other. The answer is important, even if the implications of that answer aren’t immediately obvious–or even intuitive. Despite what many people think, you don’t need a lot of people to start a corporation and, similarly, there’s no reason you should dismiss the LLC model or the partnership model outright just because you have multiple founders and a number of employees.
A lot of companies start with a few friends working together out of their homes or someone’s garage. When it comes time to formalize the business by choosing a structure, the first question you need to answer is how many owners that business is going to have, which is not always immediately obvious. Is the person or persons you’ve been working with your partner, or your employee? Are you the only owner of your future company, or was this a group effort from the start? If there are multiple owners, do you own equal portions of the company, or (more likely) are their major and minor stakeholders?
The percentage of the business you end up owning will likely determine who controls the company itself. If you’re a group of professionals sharing ownership fairly equally, a partnership might be the right choice for you. The partnership model has a lot of flexibility as to governance and structure, as does the LLC. If you’re a growing tech company with a single founder and a number of minor stakeholders, the corporation might work best. If it’s just you, then you’ll have to decide whether you want the protection of an LLC or are comfortable working as a sole proprietor.
What kind of liability protection do you need?
One of the primary benefits of forming any kind of separate business entity is to protect yourself and your personal assets in the event of debt, bankruptcy, or legal action. A sole proprietor who gets sued by a client or customer is completely vulnerable: all of his personal assets will be considered fair game when it comes to determining his ability to pay damages in a successful lawsuit. If you’re successfully sued by a customer as a sole proprietor, you could easily lose your house and all of your savings and other financial assets.
But when you incorporate, you create another, entirely separate entity from yourself. If a corporation is sued, the plaintiff can only go after the company’s assets, not the personal assets of its owners or stockholders. The same goes for a limited liability company or LLC. An LLC is a statutorily created business entity that allows for similar liability protection to a corporation without the same structural and taxation requirements.
Partnerships (whether continuous businesses or temporary joint ventures), too, can offer protection against liability. Silent investors can take advantage of the limited partnership model to protect their own interests while still investing money in a company, and most jurisdictions allow for the creation of LLPs, or limited liability partnerships, which are the partnership equivalent of an LLC. With a general partnership, the common law presumption is that all partners are liable for the actions of the other partners. With an LLP, each partner is only liable for his or her own torts or negligence, not those of others.
How do you want to be taxed?
Taxation is a major consideration, and it’s an incredibly complex issue, so one thing I always tell every client is that they absolutely need to talk to a qualified CPA. A lawyer can structure your business to optimize it for good tax policy, but an accountant can give you specific, ongoing tax advice that just isn’t available elsewhere. What the taxation issue breaks down to when it comes to business structure is single versus double taxation. In other words, does income adhere to the business entity itself (in which case the business and its owners must be taxed–double taxation), or does it “pass through” directly to the individual owners (in which case only those individuals are taxed on their income–single taxation)? Double taxation can be a daunting idea for small emerging companies, so in the contest of LLC versus corporation, LLC often wins for this reason alone. Most companies choose another model unless they have a compelling reason to incorporate.
Partners are taxed on their individual earnings in partnerships. Multiple member LLCs are taxed as partnerships, with each owner paying taxes on their individual income. Single-member LLCs are taxed the same as sole proprietorships, with a single level of taxation on your individual earnings. LLCs can elect to be taxed as a corporation, for reasons that are worth considering but are beyond the scope of this article.
What is your long-term goal for growth?
Do you plan on keeping your company private and running it the way you see fit, or is your goal to attract outside investors and someday go public? Tech startups and other companies seeking seed investment from venture capital firms usually choose the C corporation because it is designed to accommodate growth and to allow for any number of new investors. Angel investors tend to prefer that companies be organized as a C corporation (usually a Delaware C corporation) before they will agree to make an investment in a startup.
On the other hand, if your goals don’t involve an eventual IPO and you’re mostly investing your own money, then the LLC or one of the partnership models may be the preferred way to organize your business.
How much control over the operations and internal organization of your business do you need?
Incorporation may be the preferred structure for companies primarily concerned with growth and outside investment, but it’s also the most complicated. Corporate law is quite established and there isn’t much wiggle room for unique or flexible management structures. There are also many regulatory and legal requirements for how corporations can be run, how often they must hold meetings, how often they must file taxes and other forms, etc. If your goal is to get to running your actual business as quickly and efficiently as possible, a C corporation might not be for you.
The LLC is a popular choice precisely because it is so flexible: unlike traditional corporations, limited liability companies have simpler tax requirements and involve far fewer filing obligations. Typically, most LLCs need only file a single annual report with their state of organization, they need not hold meetings, and in general can organize and run the internal workings of the business as they see fit.
Are there any other special considerations that need to be addressed?
Maybe the question should be LLC versus corporation at all. Are you a licensed professional? You may need to form a PLLC or a PLLP, which involves additional initial filings. Are you strictly a family business with a limited number of shareholders? Perhaps a closely held S corporation is the right organizational structure for you and yours. Are you a medium sized business with a large payroll? Maybe an LLC with an S corporation election could help you minimize taxes.
There’s no “right” answer for how to organize your business, no winner to “LLC versus corporation,” but there are best practices, and the best practice for you will be to organize your business in a way that reflects the unique needs of your business model.
This post isn’t comprehensive, it’s simply intended to point you in the right direction. That direction will very likely be toward an experienced business lawyer, one who can help you identify the organizational needs of your business and guide you in making the entity formation decisions that will set you on the best path to success.
BeaconLegal offers consulting and corporation formation services to individuals, startups, and emerging businesses of all types. Contact us today to get the help you need.