What Type of Entity Should My Company Be?
How to choose the right home structure for your company.
One of the most important early decisions an entrepreneur must make in connection with his or her venture is the choice of entity. We always advise our clients to form an entity that will protect against personal liability. You have three good choices: a C corporation, an S corporation or a limited liability company. Each type has pros and cons depending on your situation, but for most small businesses the LLC is the dominant choice. We also see the statistics across the United States that limited liability company (“LLC”) formations rapidly outpace all other entity types.
I like to think about entities as homes. Consider a condo, a single family home and a beautiful estate lot Mansion. Each of these home structures can accomplish very similar needs – a place to live, sleep, eat, raise a family, etc. They have particular uses, and make sense for various life stages and budgets. Yet each also have various levels of cost, operational needs, requirements, and capacity. Typically, it’s also not easy to bounce around and move from home to home. Your furniture from the 10,000 square foot home does not easily fit in a 1000 square foot condo and vice-versa. The point being is you want to make the best-fit analysis and chose once, for the long term. The same is true for your company, selecting the right entity type from the start is critical to laying the foundation to allow your company to flourish. Makes sense, right? Especially since you’re planning to be in business for a long time.
What’s the right entity for me?
Many new entrepreneurs ask us the question, “What type of company should I form?” Generally, a limited liability company (“LLC”) is our go to answer. Why? Given the small cost of forming and operating an LLC, this additional benefit is almost always worth more value to a new company. LLC’s offer limited liability for the owners, can live past the lives of the initial owners, can be very flexible with formalities (e.g., no need for ongoing monthly meetings), and can choose to be taxed as a partnership, C-Corp or S-Corp. The annual fees to maintain an LLC are also very reasonable in most cases.
But I want to raise money!
The natural follow up in our conversations turns to “I read and hear that a C-Corp is the best for raising money from investors, so I think we should use that.” Realistically, you should consider the stage and short-term future prospects in developing your company. Most business owners underestimate the amount of time it takes to build a thriving business, let alone one that compels investors to open their checkbooks.
Although, if you’re going to seek funding or know that you have great potential to raise capital quickly, you should likely form a C corporation because it offers the structure that investors will usually require. If you’re not going to seek funding (or funding may not be imminent), you may want to form an S corporation or a limited liability company to obtain “pass-through” tax treatment. Investors are becoming more familiar with LLC’s as well, weakening the C-Corp argument. It’s a good idea to know how you can use it your new LLC to your advantage, and when it actually does you and your business good.
Main Factors to Consider:
- Limited Liability (personal identity is separate from the company)
- Governance (maintaining on-going formalities)
- Ownership Structure
- Issuing Equity to Investors
- Compensation Employees
- Fiduciary obligations (each owner has obligations to other owners and investors)
The bottom line is that every situation is different, and that’s why it makes sense to sit down and discuss your options with an experienced lawyer or simply, Ask Briefcase! In the next few articles we will discuss each entity type in more detail. Stay tuned…
Questions: What type of growth is your business likely to experience in the next year, 5 years, 10 years? Are you likely to raise money? Or is it best to find a simple easy fit for digging in an focus on building your company?