Before launching your business, it’s essential to consider every aspect, including selecting the appropriate business structure. Choosing the right structure significantly impacts various aspects such as tax obligations, financing options, paperwork requirements, and liability protection.
Two prevalent structures to consider are the Limited Liability Company (LLC) and Corporation (Inc.). While both provide liability protection and operate within their respective state of formation, it’s important to note their distinct characteristics and differences.
Understanding these nuances will help you make an informed decision for your business’s long-term success.
A limited liability company (LLC) gives its owners limited liability protection of a corporation paired with the flexibility and pass-through taxation of sole proprietorships and partnerships.
In LLCs, owners are referred to as members. This is commonly used by small businesses, service providers, and startups as they are easier to set up and maintain.
LLC members benefit from limited liability protection, safeguarding their personal assets from business debts or liabilities. In other words, creditors are unable to seize personal properties, such as homes, to settle business debts.
Simply put, the extent of potential loss for LLC members is limited to their initial investment in the business.
Exploring Inc. (Corporations)
A corporation is a legal entity that is separate and distinct from its owners. The creation of a corporation gives them the same rights and responsibilities as individuals, meaning they can enter contracts, own property, make loans, engage in legal action, hire employees, pay taxes, and more.
In a corporate structure, ownership is typically categorized into three levels: parents, affiliates, and subsidiaries. Subsidiaries are owned by parents, and the level of ownership can vary from a fractional percentage to complete ownership of 100%.
A corporation has a perpetual existence, meaning it can continue even if the shareholders change or pass away. Corporations are usually companies with significant growth potential and have plans to seek external investments.
Shareholders represent the ownership of a company, whereas directors are individuals or groups entrusted with making and approving strategic decisions on behalf of the company. Shareholders hold the ultimate ownership stake, while directors are responsible for steering the company’s course at a high-level.
Liability Protection Comparison
Both LLCs and corporations offer limited liability protection for their members and shareholders. This means that the owners’ personal assets are usually shielded from the debts and legal liabilities of the business. Both entities are also protected from the personal liability of the actions and debts of their employees.
However, when it comes to internal liabilities, LLCs typically provide more protection since members are not held liable for the actions and debts of other members. This safeguards their personal assets from claims made by other members. Conversely, in the case of corporations, shareholders can potentially be held liable for the actions and debts of the corporation, depending on the circumstances.
Management and Governance
The management structure of LLCs is flexible. Members can choose whether they want to manage the company themselves or appoint managers to handle the day-to-day operations. LLCs also have less formal recordkeeping requirements and fewer regulatory requirements in some jurisdictions.
Ownership in a corporation is much stricter. Their management is centralized to the board of directors who are elected and are in charge of overall decision-making for the corporation.
Shareholders are considered the owners of the corporation but are separate from the business and operations. Membership is represented by shares of stock that are held by shareholders. These shares can be bought, sold, or transferred. Corporations may choose to return a profit to their shareholders in the form of dividends.
The LLC serves to protect its owner or member’s personal assets in the face of a lawsuit. The “pass-through” tax structure allows the profits and losses to pass through the member’s personal tax returns and avoids double taxation. The major difference between LLCs with corporations is the potential to be double taxed.
Corporations are subjected to corporate income tax on their profits and if they choose to distribute these profits as dividends to their shareholders, then the shareholders could be subject to personal income tax on the dividends. Only certain kinds of corporations are eligible for pass-through taxation like S corporations.
Flexibility and Formalities
LLCs benefit from flexible administrative requirements, allowing for simplified operations compared to corporations. On the othe rhand, corporations have stricter administrative requirements, involving formalities such as annual meetings, minutes, and shareholder records.
LLCs offer greater flexibility in ownership and transferability of interests, while corporations have structured shares with defined rules for ownership transfer.
Funding and Investment Opportunities
LLCs are owned by the members who contribute to the capital, which is flexible depending on the agreed-upon arrangement. Members can issue membership interests in order to raise capital. When it comes to raising funds, they can secure loans to borrow money but may have limitations in attracting external investors or grants from the government.
Corporations are owned by shareholders that hold shares of stock and these shares of stock serve as the corporation’s capital. In order to raise their capital, the corporation can issue shares of stock. With regard to debt financing, they can also borrow money and issue corporate bonds.
Attracting investors is easier as a corporation as there are also more regulations in place to protect investors. As stocks are traded in a stock exchange, it is much easier to transfer ownership through the selling of stocks.
Compliance and Regulatory Obligations
Both LLCs and corporations have to fulfill reporting requirements set by the state where they were formed. In general, corporations have more annual requirements than LLCs.
Corporations are required to hold annual shareholder meetings each year. Any action or change done by the business requires a corporate solution which is usually voted on at regular board meetings.
These meetings have to be properly dedicated with minutes, usually done by the corporate secretary. Corporations are also required to file annual reports regarding the business’ current information.
Choosing the Right Business Structure for Your Needs
There are several factors to be considered when deciding between an LLC and a corporation. Here are some of the big factors to consider:
Liability Protection — Consider the liability protection that you desire as both LLCs and corporations have different protection to some extent. Factor in the nature of the business and if there are potential risks involved during the operations.
Tax Implications — Evaluate the two different tax implications of both business structures and consider the impact on your own personal tax obligations. If needed, it is best to consult with a tax advisor or lawyer.
Ownership and Management — Think of the number of owners that you anticipate and the kind of flexibility that you want in your ownership. Also, consider the management structure that best reflects your preferences.
Funding — Evaluate your current pool of capital and what your future investment needs are. Corporations offer more opportunities for raising capital through the issuance of shares and external investors.
Making An Informed Decision for Long-Term Success
LLCs and corporations differ in several key aspects. LLCs offer flexibility in administrative requirements and ownership, with limited liability protection. Corporations provide strong liability protection and the ability to issue stock, attracting investors.
Considerations for choosing between them include desired liability protection, administrative obligations, ownership flexibility, and growth plans.
Finding the right business structure is important in laying the foundations of what your company can or cannot do, and set you up for future success. We have outlined the pros and cons of LLCs and corporations but the right answer would depend on your company’s priorities and circumstance.
In making an informed decision, it is best to seek professional guidance. Contact NCH today to help you get started. Learn more about our services by visiting our website.
DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.