The process of launching your new business involves many steps, both small and large. Choosing the type of business structure for your new venture is one of the most important decisions you will make. The choice or entity type will influence your company’s organization, finances, paperwork, and your relationship to your business.
A new business owner would be wise to consider how each business structure would impact his or her personal assets, the way the structure would dictate the business’s management, the general tax implications of the structure, and the estimated state filing fee for that particular structure.
Common business structures
Most businesses choose to organize as either a corporation or a limited liability company (sometimes referred to as an “LLC”). There are two types of corporations: C corporations (sometimes called “C corps”) and S corporations (sometimes referred to as “S corps”). Read ahead for a quick primer on each structure:
A majority of the world’s largest companies are C corps because it is the easiest and most common form when an owner prioritizes selling lots of equity to investors and shareholders. This structure is the primary investment choice for venture capitalists, and is the usual format for most of the publicly-traded companies you see on stock exchanges. But being publicly traded comes with a downside: strict regulation. This means a C corp must create bylaws, host annual meetings, organize director meetings, and distribute of shares. The recurring paperwork and administrative tasks associated with these regulations may strain company resources and staff. In addition, “going public” brings on an additional layer of administration and regulatory compliance. C corps are also subject to double taxation, as the income of the company is taxed at the corporate level and then again at the shareholder level.
S corps may be subject to many of the same formalities as a C corp, but they offer their owners more flexibility. A sizable advantage offered by the S corp is pass-through taxation—meaning the company’s profits are only taxed once. S corps are able to be exempt from corporate income tax. Profits are taxed via the owner’s private income tax. With regard to investors and shareholders, S corps are limited to only 100 shareholders who are often the employees. But, S Corp shareholders may not be business trusts or subsidiary companies. Additionally, all shareholders must be U.S. citizens or residents. This sometimes creates a serious barrier for international organizations.
Forming an LLC is the easiest and most flexible way to start your business. LLCs provide personal asset protection. This means that, in the event of your business’s failure, your personal assets are shielded from collection to pay your business’s debts. The LLC offers a flexible management structure and less annual paperwork. This allows the owner to spend more of your time and energy operating the business. However, LLCs don’t provide the option to sell any type of stock. Also, owners may be held personally liable for the company’s debts if the LLC is found to be operating in violation of its purpose.
Key differences between corporations and LLCs
There are many differences between corporations and LLCs. Some of the most considerable differences include:
LLCs and S corps both enjoy pass-through taxation, which reports all profit and losses on the personal income taxes of each owner, and are not subject to corporate-level taxes. C corps are subject to double taxation, meaning corporate profits are taxed at the corporate level and then again at the shareholder level.
Management and control
A corporation’s business decisions are made by a board of directors, which cannot be dissolved except under very limited circumstances. A corporation’s rules and regulations are dictated by formal bylaws. There is little opportunity for flexibility, or to insert additional provisions, once the bylaws are in place. An LLC can elect managers to make the decisions (much like a board of directors), or an LLC can elect to managed by all of the members/owners. Keep in mind that a member’s involvement is directly proportional to his or her share of ownership.
Ownership and longevity
Changes in the ownership of a corporation can be easily accomplished via the sale of stock to new or existing shareholders. Similarly, a corporation can exist beyond the lifetime of its founders, as they are separate entities and will survive the transfer of stock from the owners and major shareholders, no matter the reason for transfer. LLCs are usually more rigid in regards to changes in ownership, as the ability to adjust ownership is dictated by the terms of the operating agreement.
Because shares of corporate stock can be traded on the public market, an annual distribution of dividends is not guaranteed. Dividends are declared by a company’s board of directors and are typically ordered when profits are high. Issuing dividends is a straightforward way for a company to indicate financial health and positive future performance. However, a board of directors may choose to reinvest the company’s profits in business infrastructure or development rather than paying dividends. Many start-up companies choose to reinvest rather than immediately distribute dividends. Members of an LLC cannot receive dividend payments because ownership of an LLC isn’t represented through shares of stock. However, profits may be redistributed at the members’ discretion or according to an operating agreement. Members must pay income tax on an LLC’s profits regardless of whether redistribution payments were issued, whereas corporate shareholders are only responsible for income tax on dividends.
Swyft can help!
When deciding the correct type of business entity for your company, think about how your decision will affect your company both in the early days and down the road. If you need further assistance, our business specialists are available to answer questions and support you during your planning stages.Contact us today!