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 st