Starting Your Business: LLC vs. Corporation

This is a follow up to a guest post by my good friend Jesse Jones on Three Legal Mistakes that Can Sink Your Company. I got a number of responses to that post asking for a follow up on what was the best legal structure for a new company. Jesse was kind enough to provide the answer in the post below.

You can find Jesse’s contact information at the end of this post if you want to reach out to him directly.

Obligatory disclosure: None of this post should be considered legal advice provided by me. I’m not an attorney, nor do I have any desire to be one!

Here’s Jesse with part two of his legal series.

As a business attorney focused on helping entrepreneurs develop startups into healthy, thriving businesses, I probably get the following question 3-5x a week: Should I set up my company as an LLC or a corporation?

LLCs

The Limited Liability Company has several benefits, and depending on the facts, an LLC can be the simplest form of entity (a single member LLC) or the most mind-bending web of complexity known to corporate lawyers.

One of the biggest benefits of LLCs is that there is no entity-level taxation, enabling owners to flow income generated by the LLC directly through to their personal tax returns.

Also, LLCs are very flexible in how they can be constructed. If the partners can dream it up, it can become a part of the operating agreement. You can customize voting, allocation of profits, and distributions, allowing for cash to be distributed to the owners without regard to their percent ownership of the entity.

LLCs are fantastic, in my opinion, for so-called “lifestyle businesses”, where entrepreneurs are creating a company that will grow organically through operations, as opposed to businesses that plan to seek angel or venture investment. If you plan to seek outside funding or venture capital, most VCs will force you to convert to a corporation prior to making any investment. Some venture funds are even prohibited from making investments in entities that provide a flow-through taxation model.

The good news is that you can normally convert your LLC to a Corporation in a tax-free transaction, so even if you start out as an LLC it’s not the end of the world to convert.

Corporations

Corporations are designed to handle situations that demand sophisticated uniformity in terms of ownership and governance. Corporations typically involve double taxation, with taxes being assessed at the corporate and individual level. The notable exception is the S-Corp designation.

With a corporate structure, it is much easier to add investors to the company’s capitalization chart (which is just a fancy word for the record of who owns what), which is why most investors will demand this form of entity before they invest.

The Corporation also empowers the board of directors to easily issue equity compensation in the form of stock options to employees, vendors and other service providers.

Due to the added legal formalities as compared to the LLC, and double taxation, the Corporation may be more costly and time-consuming to maintain. Corporate maintenance typically requires more legal counsel due to the need to document board meetings and written consents that may not be necessary with an LLC.

From a tax preparation standpoint, corporations typically fall somewhere between the single-member LLC and multi-member LLCs in terms of complexity – thanks to Josh Holley from the Tripoli Group for his assistance here.

Educate Yourself and Make a Good Choice

A business attorney can help you make an educated decision on the right entity for you and your partners, keeping in mind both present and future business needs. With proper planning, you’ll have the flexibility to accommodate your business’s full potential.

Just remember that either form – LLC or Corporation – is better than none! By forming a legal entity using either of these options, you can avoid personal liability in most cases, which means no one can take your house or your car for something the business did or did not do.

About Jesse Jones

Jesse Jones joined the Forrest Firm after six years representing corporate clients at Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan in Raleigh and Morris, Nichols, Arsht & Tunnell LLP in Wilmington, Delaware.

Jesse focuses on counseling early stage and high growth business clients in all types of transactions from formation to exit, in addition to serving as outside counsel to more mature organizations. He seeks to provide practical and thoughtful advice to help clients refine and achieve their goals.  Specific areas of practice include start-up counseling, seed, venture capital, and debt financings, mergers and acquisitions, and the negotiation and structuring of a wide range of contracts and transactions.

If you want to contact Jesse directly about anything you’ve read here, you can find him on Twitter at @jjonesJD or via email at jesse@forrestfirm.com.