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Which corporate structure is best for a start-up?
This article in Entrepreneur suggests that many entrepreneurs give insufficient thought to the corporate structure of their start-ups, that they “check (it) off their list on a weekday night after researching on the web for an hour or so.”
LLCs, S-Corps, and C-Corps offer different advantages and restrictions, and choosing poorly can lead to expensive and difficult changes down the road. There are many complexities and issues to consider and no one right answer. You can, however, reduce the number of future headaches (and possibly legal bills) if you choose the structure that is most appropriate for both your current situation and your long-term objectives.
Aside from avoiding personal exposure to business liabilities, the main considerations when choosing from among the three structures are i) tax consequences, such as maximizing the benefit of start-up losses, avoiding double taxation, ordinary income versus capital gains treatment and state nexus issues, and ii) corporate governance issues.
C’s and LLC’s tend to dominate the landscape of venture-backed companies because an S allows only up to 100 shareholders and one class of stock, and does not allow corporations or partnerships to be shareholders.
We have invested in both C’s and LLC’s with success over the years, and wrote this White Paper on the topic to provide an unbiased perspective and help educate entrepreneurs on the benefits and potential drawbacks of each structure.
We invite you to read the White Paper, but, very briefly: in our experience, very few venture-backed LLCs benefit much in the area of tax avoidance and the defined governance structure of a C-corp is almost always preferable. Moreover, the high legal costs and ambiguity associated with some Operating Agreements that accompany the LLC structure make it a potentially disadvan- tageous approach relative to the C-corp.
That being said, we have seen situations where an LLC structure makes sense for everyone involved and we discuss that with entrepreneurs when it is the case.
Think hard about your long term goals for the business when getting advice on your legal structure. Just as people shouldn’t decide to have children for the tax benefits, we advise that you don’t view tax considerations in a vacuum when choosing the legal structure of your business.