Picking which entity to use in a startup

Young entrepreneurs have many options they can use when forming a new business entity, with LLCs and S Corporations providing significant appeal to individuals who are just looking to start out their entrepreneurial careers.

One major benefit of setting up a corporation is separating the personal and business assets of an entrepreneur, which reduces the liability of business owners in case issues occur with vendors or lawsuits are filed. Another benefit that can be derived from establishing a corporation is easier access to funding in the form of equity or debt.

Some business owners opt to form C Corporations, which provide the benefit of having an easier time issuing shares and the ability to hold an initial public offering when that option is desired. However, this business entity comes along with various requirements and the detriment of double taxation.

C Corporations need to pay both federal and state taxes, and any remaining profits that are paid out to shareholders are once again taxed. Business owners who want to operate these legal entities will need to fill various requirements including filing annual reports and establishing a board of directors. Owners of C Corporations will need to deal with more compliance and other documentation as well.

S Corporations have the same requirements, but the owners must first incorporate as C Corporations and then file a form under subchapter S to create the business entity. S Corporations can have up to 100 shareholders, and one class of stock. Shareholders need to be either U.S. citizens or permanent residents of the country.

One benefit of these corporations is that they are pass-through entities, meaning that they are not taxed at the corporate level. Any profits are passed on to shareholders, who file their own taxes.

LLCs offer business owners the tax benefits of S Corporations, but have fewer requirements and also more options. LLCs can offer their shareholders both common and preferred stock. Whereas profits and losses must be distributed equally among the shareholders, the owners of a LLC can make arrangements to divide the earnings and losses unequally.

For example, if four owners decide they want to set up a LLC and then later on, one of them wants to get a full-time job and still contribute to the business venture on a part-time basis, the shareholders could decide to allocate a smaller portion of the profits and losses to this individual. 

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