C Corporation vs. LLC for Startups Advantages and Disadvantages of an LLC A limited liability company ( LLC ) provides shareholders with many of the same protections at a C Corporation and safeguards their actions from personal liability. Indeed, an LLC may even provide extra protection at times because its structure is less formalized and requires less reporting. Therefore, there are not as many causes for action to pierce the corporate veil or treat the company like an individual. Overall there is much less paperwork to file and technical procedures that have to be followed to maintain an LLC. A LLC is considered a pass through entity for tax purposes, which means that shareholders in an LLC only have to pay taxes on their personal gain and nothing in corporate tax. Shareholders are taxed in proportion to their ownership percentage. This is a tremendous advantage for start-up companies who can avoid business and sometimes personal taxes when the company is growing and before it begins to show a profit. In addition, a LLC uses an Operating Agreement instead of By-Laws, which are typically easier to amend. In addition, an LLC may be an advantageous vehicle for start up entrepreneurs if their company is going to show a loss. Here the members of the LLC may be able to take the losses associated with the business and use them to reduce their tax liability on their ordinary income. They can typically do so to the extent of their basis. In contracts, the losses accrued under a C Corporation can not be passed on to the shareholders. Rather they can be carried back 2 years or carried forward 20 years to reduce the gains to at the corporate level. There are some drawbacks to using a LLC. Most states cap the number of members a LLC can have. For this reason, and others, LLCs are not the preferred method of incorporation for public companies or companies that intend to eventually have an IPO. LLCs are a relatively recent corporate invention, and as such, the courts are still analyzing their benefits versus potential drawbacks. While the benefits to the business owners are clear, courts may begin to take a more hard-line approach to the freedoms extended to LLCs. In addition an LLC is a more difficult vehicle to use in a venture business. Where there are numerous investors and equity stakeholders, the ability to offer shares and stock options is very advantageous. An LLC is much more limited in its ability to provide for the division of equity amongst many different parties. In addition, venture capital firms are hesitant to invest in companies that are structured as an LLC. Typically they will require that the LLC be converted to a Delaware Corporation before the investment is made. When this conversion is anticipated early on, the process of turning an LLC into a C Corporation can be a relatively hassle free process. Advantages and Disadvantages of a C Corporation A Common Law Corporation (C Corp) is the most recognized and common entity for large corporations and public companies. Both the public and the courts are familiar with the structure of the C Corp and there is a general sense of security that accompanies dealing with this type of entity. Like a LLC, a C Corp affords its shareholders limited liability. However, unlike a LLC, a C Corp can have an unlimited amount of shareholders and is the preferred type of vehicle when taking a company public. A C Corp has disadvantages, especially for start-up companies. Most notably, it is the only corporate entity that is taxed twice, both on its corporate profits and on the profits to its shareholders. In addition, the filing and reporting procedures for a C Corp can be complicated and cumbersome. However, C Corporations are the preferred entity for most investors. Incorporating in Delaware vs. California Delaware is widely regarded by the business community as the friendliest state to corporations and is typically where many public companies incorporate. Foremost, directors and officers are usually afforded the most protection by the Delaware courts. The courts are considered very knowledgeable about business affairs, and due to their case load, stay current with modern business trends. However, to incorporate in the state businesses have to pay the Delaware Franchise Tax, which is determined based on the capitalization of a company, which can be a significant cost. By contrast, California courts can be uncommonly tough on management, but there are advantages to incorporating in California. If the company is primarily based in state, there may be cost savings associated with remaining. In addition, if litigation is brought against the company, shareholders would not necessarily have to travel to a different state to try the case. The most important reason for incorporating in California may be §2115 of the California Corporations Code, which mandates that California rules apply to corporations incorporated in another state if the corporation is primarily based in California. Under this rule, a company would be responsible for both CA laws and the laws of the state they incorporate in, as long as it can be established that the company is principally based in CA.
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