C-Corp, S-Corp, or LLC?
How Do I Decide Which Entity To Go With?
This is probably one of the most frequently asked business legal questions of all time: which entity should I organize by business under and why? Well, it depends (typical attorney answer). Business owners organize (formation of entity) for tax and liability purposes. For the typical owner, your tax structure most likely won’t be impacted much in determining which entity to go with; most entities by default provide level of tax advantages versus operating as a sole-proprietor. Although there is no substitution for speaking with a business attorney regarding the topic, the following are points you should think about:
1. Business Type
Most small businesses are formed under the corporation or LLC (limited liability company) structure. Your small mom-and-pop restaurants, liquor stores, hair salons, etc. don’t require any specialized type of entity. A specialized type of entity referred to would be required for professional businesses, such as a law firm or a doctor’s office. Professional businesses are sometimes required to form a professional version of either a corporation or LLC. These forms typically restrict the ownership to those that are licensed to practice that profession in their respective state.
2. Type and Number of Owners
Entities are restricted in the number of and types of owners owning shares or units in the company. Some entities don’t have restrictions, while others have strict restrictions. C-corporations and general LLCs aren’t restricted by the number and or type of owners owning an interest in the company. However, S-corporations are limited to no more than 100 shareholders. The differences between a C-corporation and an S-corporation is outside the scope of this article, but generally involve issues regarding taxation and profit distribution.
3. State of Organization
Although not a huge issue to take into account, but one that should be thought about regarding the nature and scope of your business. Say for example you own a real estate brokerage service that serves both Michigan and Nevada residents. Nevada doesn’t impose a corporate tax on corporations organized in that state, while Michigan does. Wouldn’t it make sense for a company that legitimately operates in both states to organize in Nevada and avoid the corporate taxes levied on Michigan’s corporations? Sure it does. While this is a simple concept, consult with your business attorney for further clarification.
4. Limited Liability
Limiting the amount of liability and or exposure to liability should be a top priority or any aspiring or current owner. One of the most important aspects of organizing is to limit as much liability as possible. Business owners tend to downplay the importance of limiting liability to avoid paying for professional advice regarding the limitation thereof, but end up paying dearly in the long run. Just ask the liquor store owner that lost everything he owned and some to the customer that slipped and broke his back in the store, he’ll tell ya. When it comes to liability exposure, the potential plaintiff that seeks damages is limited to the assets of that business and nothing else. The owner’s personal assets are largely off-limits.
5. Future Funding
Unless you think you have the next Facebook or Twitter and will be seeking future venture capital funding, this point is largely out of your scope. Most venture capital companies can’t invest in companies organized as LLCs. The reasons are complicated and don’t make much logical sense, but it is what it is. LLCs that do attract venture capital funding oftentimes have to go through the process of re-organizing under a C-corporation, which usually requires some big legal bucks. Save yourself the hassle and do it right the first time around.
Deciding what type of entity to organize under should be left to your attorney to determine, don’t attempt to figure it out on your own, you will regret it later.