So you’ve decided to start a business. Once you get past the initial excitement of throwing ideas around with your co-founders, it’s time to make your first big decision: how you’ll structure your organization.
Choosing a corporate entity type can feel overwhelming if you’ve never done it before. And even if you have, each industry and business has unique needs.
In this article, we’ll break down some important details you need to know about the two most common types of entities: a C corporation (commonly referred to as a C corp) and an LLC.
Why taxation is at the root of your corporate structure decision
In the U.S., taxes play a huge role in business entity selection. Let’s talk about how taxation affects each of the two major entities we’re exploring.
A C corporation is a taxpayer itself, whereas an LLC filters its tax liability down to the individual owners.
Many entrepreneurs choose to start out with an LLC because they know they’re going to endure losses in the beginning. Those losses can be split amongst the members of the LLC, who may use them to offset their income.
If a C-corp endures a loss, it’s carried forward and must be offset by future gains. Think about a C-corp as a person who pays their own taxes. They can’t push any liability onto other individuals or entities and instead take a personal hit on profits until the books are in the black.
The core differences between a C-corp and an LLC
Aside from taxation, there are other stark points of contrast between these two ways of setting up your business. The most obvious is the strictness differential.
A C-corp can feel tightly controlled — it’s very corporate. You must assign officers, have a board of directors, and an annual shareholders meeting. There are also high incorporation and annual filing fees.
An LLC is a bit of a looser arrangement. It’s a partnership, managed by a contract that you can alter anytime with approval from all members.
Both options are appropriate for startups, but it’s typically easier to attract investors if you form a C-corp due to the tax advantages, including the Qualified Small Business Stock exemption.
Which entity is right for your business?
It’s important to take your time choosing an initial corporate structure. Get advice from other startup founders in your industry, as well as legal and financial experts, before selecting an entity type.
Also, consider the specific requirements for registering a business in your state.
Whichever entity type you settle on, it will impact many of the future decisions you have to make concerning your business — including how you’ll go about valuing your business and raising capital.