When starting a company, founders should become familiar with types of business entities before deciding if and how to incorporate. LLCs and corporations are typical forms of entity used by startups. Although both provide similar liability protection for owners, there are several key differences as highlighted below.
LLCs are limited liability companies. These companies offer more flexibility regarding management and taxation and require fewer record keeping requirements. Owners are called members and own a percentage of the business, which is sometimes called a membership interest. These members act like partners. They can be involved in managing LLCs (member-managed) or can appoint someone else (manager-managed). The operating agreement, an enforceable contract among members, can control a new company’s management structure. There are often restrictions on transferring membership interests in LLCs. The approval of other members can be required, while some states require that LLCs are dissolved if a member leaves. These companies do not have their own tax classification and founders can choose how they are taxed, whether it be as sole proprietorship, a partnership, an S corporation, or a C corporation.
Corporations, on the other hand, offer greater structure and the ability to transfer shares easily. Owners of corporations are called shareholders and are issued shares to correspond with their percent of ownership. These shares are easy to transfer from one person to the other, giving corporations perpetual life. The management structure at these companies is more rigid, often compromised of a board of directors for broad oversight and various officers for managing the day-to-day. Corporations will hold annual shareholder meetings, issue annual reports, and have more reporting requirements to meet. They are taxed as either C corporations or S corporations.
Decisions regarding corporate form are incredibly important, and should be made in consultation with the appropriate legal and tax resources. A startup lawyer is typically a source of valuable information and advice on such matters.
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