LLC Or Corporation: What Structure Should You Establish For Your Business?

Posted by Michael Kanayo on June 4th, 2019

Introduction 

In the age of start-ups and exponential advances in technology, more and more people are starting new ventures and trying their hands at entrepreneurship. Before you rush into things, however, you want to ensure that your great idea is managed and protected in the best possible way. Understanding how best to structure your new business is more important than ever.

Most new companies are incorporated either as a Limited Liability Company (LLC) or a Corporation. Understanding the differences in these structures is a key starting point. Both of these entities are legal “persons” – in other words, they exist separately from their members or shareholders, and the liabilities of your LLC or your corporation are not your own. But there are several ways in which the two entities differ. Before you begin down the road of creating an LLC or a corporation, consider carefully the pros and cons of each.

LLC v Corporation – The Facts in a Nutshell

When it comes to understanding how your path to running a successful company may differ, the starting points should be in the formation of the enterprise. In fact, the first difference you will encounter is in the manner of forming your company. An LLC is formed by one or more people called "members". These members file Articles of Organization and set out an Operating Agreement, and they personally oversee the operations of their business.

A corporation is formed by filing corporate organization documents in the state where the corporation is located, and by designating shareholders, each with a specific number of shares. The corporation also requires a board of directors, tasked with the management of the corporation’s business.

While the members of an LLC are its owners, transfer of ownership and investment into the corporation happens by purchase and issue of shares, and the management tasks are performed by the directors, who need not and often are not shareholders. The members of an LLC have an equity interest in the assets of the business, reflected in the business’ accounts. Conversely, owners of a corporation have shares of stock which they can sell without impacting the business’ value. Unlike the member’s relationship to the LLC’s financial accounts, a shareholder’s stock in the corporation is reflected quite separately from the corporate business’ financials.

The profits and losses of an LLC and a corporation are handled differently. LLC profits and losses are passed through to individuals, while corporate profits and losses are held by the corporation – owners in a corporation realize value by selling shares or when the corporation’s directors decide to pay shareholders dividends.

Finally, we turn our attention to the taxman. While there are of course tax implication in both company structures, corporations and LLCs are quite different in how they are taxed. While corporations are taxed at the prevailing corporate tax rate, an LLC is taxed based on the gross income of its owners or on what’s called a “pass-through taxation”.

Understand What You Are Working Towards

Ultimately, the most important determinant of what type of business enterprise to go with is your business goals. Because of the ownership structure of LLCs, the corporate structure is much more inviting to new investors, and if you are seeking investors with little interest in being involved with the day to day operations of your business, a corporation is certainly your preferred route. If the success of your business relies, from the outset, on the buy-in of a broad investor pool hoping to profit from the sale of their shares once your business begins to prosper, an LLC may be a structure to steer clear from.

However, there are often great benefits in starting out with an LLC. We have looked already at the fact that corporations are subject to corporate tax. This means that owners of a corporation could have the value of their corporation impacted by tax, and then be taxed again on their dividends payments. This double taxation problem may not rear its head too often if dividends are limited, but it does mean that entrepreneurs seeking to build from a small base may prefer the LLC structure. Beginning with an LLC does not tie you down forever. Perhaps you might find, a few years down the line, the scope for growth has built up to a point where it makes sense to bring in a range of investors, and you want to convert your LLC into a corporation. That process is doable and not overly taxing.

Do Not Skimp on Expert Advice

Ultimately, the most prudent approach to take is to consult a business attorney with expertise in the formation and management of both LLCs and corporations. While this may involve an extra cost and perhaps some delay in getting off the ground, it is a worthwhile sacrifice in the long run. The enterprise you choose may be one of the key business decisions you make, so it is worth carefully considering the perfect suit for your personal goals.

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Michael Kanayo

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Michael Kanayo
Joined: May 17th, 2019
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