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The question for young entrepreneurs is frequently asked, what is the best legal form of business for a new, startup company. The most commonly selected choices are LLC’s and S-corps, which each have their own strengths and weaknesses.
The LLC is a very easy-to-set-up legal entity. It is fairly cheap to set up, does not require the recording of minutes, require less administration, and offers excellent flexibility. The members of an LLC can divide the profits of the company up any way they see fit, and are not encumbered by the limitations of shareholding owners that S-corps have. They offer approximately the same amount of liability protection that corporations do, but are subject to termination more easily. Whereas corporations exist perpetually, LLC’s terminate upon the death of shareholders or bankruptcy.
The chief limitation of the LLC is the inability to raise money publicly. To do so, an LLC must go through a complicated (and costly) process involving the creation of a new corporate entity, the merger of the orginal LLC into the new entity, a transition of holdings and then the dissolvation of the LLC. While these may sound limiting, the LLC is still the best legal form of business for someone who wants lots of independent control and flexibility over his small business.
The S-corp is generally the choice for entrepreneurs that intend on expanding their businesses into venture capital. While they cap at 75 members, S-corps can become C-corps with a simple change in tax election. No money, lawyers or accountants are needed. They enjoy the same pass-through taxation as LLC’s do, and are not subject to self-employment tax (as long as stockholder-employees get compensation for the earnings.)
The S-corp, however, is slightly more difficult to set up and is subject to some stricter regulations. The S-corp requires documented minutes of meetings, and requires that dividends of the corporation be paid out to the owners as percentages based on the holdings of their shares. So, for example, if you started an S-corp with one other partner and you put up $20,000 in share capital and your partner put up $80,000, all dividends would be paid out 20/80, regardless of the amount of work contributed. However, even with all of these complications, the S-corp is still the best legal form of business for entrepreneurs looking to branch out into the venture capital market.
