LLC, C-Corp, S-Corp: Which Business Structure To Choose?

Few decisions are as important as choosing the right entity for your startup. This decision is so difficult partly because at the early stage of launching a business, there are so many unknowns.

Ultimately, founders should reflect on corporate culture, management style, need for institutional funding, and inclination to reinvest profits into their business. These four considerations are key to determining which entity is the best fit.

A LLC is the most popular business entity. In relationship to every corporation, two LLCs are formed in the United States. The hallmarks of an LLC include flexibility, lack of corporate formality and pass-through taxation.

LLC statutes complete freedom to business owners to write their own rules and procedures and run the entity as they see fit. For this reason, it is a great choice of entity for small businesses and startups built as small businesses.

However, the greatest benefit of a LLC, its flexibility, is also the source of its greatest danger, and the reason why LLCs are so often misused. When an LLC operates without an operating agreement or with one pulled from the Internet, serious pitfalls may arise. The reason is that LLC's are meant to be “creatures of contract”: the operating agreement is supposed to set the internal rules, not the LLC statutes. So, if these internal rules fall short, the startup can get into real trouble.

Additionally, LLC profits are not taxed at the entity level, they are passed through to its members who pay taxes at their individual level. In contrast, a corporation pays taxes at the business and individual levels.

C-Corporation

A C-Corporation is the entity choice of virtually all companies trading on the stock exchange. It’s copious formalities, predictable rules and procedures, and ability to efficiently raise and retain capital are the chief reasons to choose a  C-Corporation.

A C-Corporation is the only viable entity for startups seeking to raise V.C. or angel investors funding because of predictability, simpler tax implications, and the ability to participate in tax-free stock swaps.

Overall, a C-Corporation, is best when hierarchical, formal decision-making is needed, institutional funding is sought, and when capital will be accumulated and reinvested in the company. A C-Corp is the gold standard of startups set for rapid human and financial capital expansions.

S-Corporation

A S-Corporation is a great option. Similar to a LLC, it is a pass-through entity, and like the C-Corp, it is subject to stringent internal and external formalities.

A S-Corp also has three unique restrictions:

1. It cannot have more than 100 shareholders
2. It's shareholders must be US Citizens or permanent residents
3. It can only have one class of stock

One important tax benefit of S-Corporations is that a portion of the profits is not subject to self-employment taxes – whereas all profits are subject to it in an LLC. This can result in substantial tax gain. However, tax attorneys are needed at every step of the formation and financing process of S-Corps, which obviously ramps up the cost of formation, at a time where startups’ resources tend to be scarce.

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