What Are LLCs vs. Corporations?
Let’s begin by briefly differentiating between what is an LLC and what is a corporation.
What Is an LLC?
An LLC (or limited liability company) is a simple business structure that designates a business as a formal legal entity. LLCs are registered with the state and provide liability protection for business owners and their personal assets.
LLCs are owned and most often managed by their members (member-managed), although some LLCs may appoint a manager (manager-managed) to run the business.
In many states, LLCs provide continuity of the business, as the business will continue to exist even if one of the members leaves the business or passes away. However, in other states, you may need to dissolve the LLC and reform another upon the exit or death of one of the LLC members.
LLCs are easy to start and maintain, offer management and ownership flexibility, and have several options for how they choose to be taxed, making them a popular choice for a wide variety of business types and sizes.
Recommended: Hiring a professional service will help simplify the LLC formation process for you. Check out our review of the best LLC services!
What Is a Corporation?
A corporation is a more complex business structure that designates a business as a formal legal entity. Corporations are also created through registration with the state and provide limited liability, protecting the assets of their owners.
Corporations are more formal, less flexible legal entities, and they are required to follow more complex operating procedures than LLCs.
Corporations are owned by shareholders and managed by a board of directors.
Corporations provide continuity of the business, as corporations continue to exist even if one of its shareholders or directors exit the business or pass away.
Although corporations are more difficult to form and maintain than LLCs, they can choose among several tax treatments, provide the greatest ease in transfer of ownership, can issue stock, and are much more investor-friendly. This makes them a popular choice among startups with growth aspirations and those that hope to take on investors.
Recommended: Hiring a professional service will help simplify the incorporation process for you. Check out our review of the best online incorporation services for startups!
LLC vs. C Corp for a Startup Company
So which form of incorporation is right for your startup? The answer to this question depends on the nature of your startup. There are several distinct differences between starting an LLC and starting a corporation that may fit some types of startups better than others.
Here is what you need to consider when deciding whether to form an LLC or start a corporation:
C Corp vs. LLC: Things to Consider
Both LLCs and corporations offer many of the same advantages of incorporation, including limited personal liability, continuance (in most states), and some degree of ownership flexibility. However, the nature of your startup, the need for a complex legal structure, your taxation situation, your funding plan, and whether you intend to issue stock are all aspects you should consider when choosing between forming an LLC or incorporating as a corporation.
Whether you decide to form an LLC or a corporation depends on the nature of your startup. You need to ask yourself what type of startup you are trying to create. How big do you hope or plan to grow your startup?
- Do you plan to start a small, owner-managed company or to build a large company with outside investors?
- Do you desire flexibility in ownership and management, or do you prefer a more formal structure?
- Are you relying on self-funding, loans, and individual investors, or do you plan to raise funds from angel funds or venture capital?
Although there are a number of other considerations, the nature of your startup is one of the most important considerations in deciding whether you should form an LLC or a corporation.
A second thing to consider in choosing between an LLC and a corporation is their simplicity. LLCs and corporations differ significantly in their ease to form and maintain.
Starting and maintaining an LLC is much simpler than starting and maintaining a corporation.
In most states, LLCs are required to file the Articles of Organization, typically a short document where the LLC provides the LLC’s name, address, members and/or managers, and the primary purpose or nature of the business. Some states refer to this as a Certificate of Formation or Certificate of Organization.
Corporations, on the other hand, are required to file Articles of Incorporation, bylaws, Action of (the) Incorporator documents, founder stock purchase agreements, and shareholders’ agreements, among others, in most states. Some states refer to this as a Certificate of Incorporation or Certificate of Formation.
Corporations are also required to hold periodic board meetings, keep detailed minutes of these meetings, and file annual reports. Whereas LLCs have far fewer requirements and rules to adhere to, making them a simpler business structure to maintain.
A third consideration in choosing between an LLC and a corporation is taxation. Both LLCs and corporations can choose the tax structure under which they want to operate. By default, LLCs are taxed as pass-through entities — either as sole proprietors or partnerships. However, LLCs can also elect to be taxed as S corporations or as C corporations.
Corporations can also elect the tax structure under which they want to operate. Corporations can elect to be taxed as S corporations (which are taxed under a hybrid, pass-through tax structure) or as C corporations.
The major difference between forming an LLC and a corporation is that an LLC can elect to be taxed as a sole proprietorship or a partnership (i.e., a disregarded entity), whereas a corporation cannot. Taxation ultimately comes down to the LLC or corporation’s choice of tax structure.
Choosing the right type of tax designation depends on the unique characteristics and needs of your business, and these may even change over time.
Another thing to consider in choosing between an LLC and a corporation is investor friendliness. If you are seeking an investment, it is likely that your investors will want — or rather demand — that you are incorporated. Most investors are not willing to invest without the personal liability protection, taxation advantages, and ease of transferability of shares provided by incorporation.
LLCs, S corporations, and C corporations each have differing rules for investors and treat taxation differently. While many founders and co-founders prefer the simpler pass-through taxation structure found in LLCs and S corporations, investors typically prefer the corporation to be taxed, and investors report and pay tax on the capital gains only when the gains are realized.
There are additional restrictions in taking on investment depending on whether you are an LLC, an S corporation, or a C corporation. Non-human investors (e.g., angel funds, venture capital funds, etc.) can not invest in LLCs or S corporations, so if you hope to raise money from angel funds or venture capital, a C corporation is likely your only choice.
Recommended: Read our guide on Why Formal Investors Prefer Working With C Corporations to learn more about why the type of corporation you choose matters to investors.
Another consideration for whether you should form an LLC or a corporation is the issuance of stock. Many startups wish to issue stock. Startups seeking investors often hope to issue stock to attract investment. And, just as commonly, in the early, cash-strapped days of new ventures, many startups wish to compensate early employees, advisors, supplies, and vendors with shares of stock or stock options in the company.
However, LLCs do not issue stock and do not have stockholders or shareholders. If you wish to issue shares of stock or stock options in the company, your startup needs to be incorporated as a corporation.
Recommended: Still need help choosing a business structure? Visit our LLC vs. Corporation or How to Choose a Business Structure guide to find more information on which structure is best for your small business.
The Bottom Line
The decision to form an LLC or a corporation depends on the nature of your startup. LLCs are simpler structures that are often better for small, owner-managed startups that are not planning on raising institutional or venture investments. Corporations are more complex business entities that are better suited for startups that want to raise significant outside investment and achieve significant growth.
Choose LLC for Your Startup If:
- You plan to start a small owner-managed business
- You desire flexibility in designating ownership in the business
- You are not seeking angel or venture capital investments
Choose Corporation for Your Startup If:
- You plan to build a large company with outside investors
- You want to retain and reinvest profits
- You are looking to raise institutional or venture capital
- You plan to take the company public
Start a Corporation using our free guide or have a professional service form a corporation for you.