1. Should Your Startup Be a Corporation or LLC?
2. Pros to LLCs
3. C-Corps vs. LLCs

An LLC startup is the easiest business structure to form, with most people being able to create one without an attorney or exorbitant fees. There are advantages and disadvantages to this business type, so knowing what you envision for your company can help you choose the most appropriate structure for you.

Should Your Startup Be a Corporation or LLC?

In the U.S., most business founders consider one of three primary types of entities to create, such as the following: 

When deciding which business type to form, you'll need to ask yourself if you'll be looking for outside investors and if your company has the potential to generate a profit in the near future.

In an S-corp, company shareholders pay income tax on the business's taxable income. The amount they pay is based on their share of stock ownership. The business itself is not subject to federal income tax.

Like an S-corp, an LLC is considered a pass-through entity. This means the LLC owners (also called members) pay taxes on the business income. Each member's portion is spelled out in the LLC agreement. If an LLC has multiple owners (similar to a business that has investors), it's treated like a partnership. For tax purposes, the members are considered partners.

C-corps are subject to federal income tax and state tax. These businesses pay taxes on their net income. Shareholders are only taxed if the business pays them in the following forms: 

  • Dividends 
  • Salary 
  • Distributions 

Dividends come out of net income, so they're taxed twice. Startups that are after venture capital are better off incorporating as C-corps instead of LLCs. However, LLCs are actually highly customizable and can be set up in a way similar to a C-corp.

Pros to LLCs

It's easy and inexpensive to set up an LLC. As an owner, you can define the members and the percentage of the company that each member owns. 

One of the advantages of an LLC is the general lack of regulatory obligations. Plus, there are far fewer arduous rules to stick to, compared to a C-corp. Another advantage of an LLC is that the business isn't taxed as an entity. Members are taxed, typically in a ratio that reflects their percentage share.

An LLC with multiple members will be taxed as a partnership. Each member submits a personal income tax return that details his or her share of profits and losses.

Startups often lose money in the beginning, but you can report your portion of that loss on your personal tax return. In the event you don't have any personal income, you have the option of rolling your loss forward to offset future income. You can also refer back to your last three years of tax returns and retroactively apply the loss. This will reduce your gross income, and you may get a refund.

C-Corps vs. LLCs

In a C-corp, the company pays tax on all income. If you get paid by the company, you'll pay taxes on the payment, so by the time you receive your money, it's taxed twice.

A C-corp has conventional structures in place for the distribution of various classes of stock. Venture capital investors usually seek preferred stock, which enables them to secure certain privileges and rights, such as the following: 

  • Rights to seats on the board 
  • Dividend and liquidation preferences 
  • Adjustments of their purchase price when stock shares are sold at a lower price than that paid by earlier investors 
  • Pro rata rights to maintain their share of ownership

LLCs don't issue stock, but they can grant ownership interests or units in the company. They can set up some rights that are similar to preferred stock. However, this can become very complicated and costly because there's no conventional model for doing this.

A C-corp is a more complex business structure because it has to stick to specific reporting requirements and keep operations and finances in good order. It also has to maintain a board of directors.

Before you decide on a business structure, carefully weigh the pros and cons of each. If you want a simple type that stays local to your community, an LLC startup could be perfect. However, if you think you may branch out (on a national or international level), consider other business structures that allow for that growth.

If you need help with starting an LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.