The US market remains one of the most attractive for scaling up a business. If you are also planning to form a business in the United States, one of the first steps you will need to take is to decide what type of legal entity to set up.
In the US, businesses often choose to operate as either an LLC (Limited Liability Company) or a corporation. The choice may vary depending on the state, but in this article, I will consider these structures’ key differences.
General Overview of LLC and Corporation
Both LLCs and corporations are legal entities that, generally, limit the liability of their members or shareholders.
An LLC is easier to establish and can be formed by a single person or multiple members, who may be individuals or legal entities, including foreign entities. In contrast, a C-Corp is a corporate structure with a more formal governance framework consisting of shareholders, directors, and officers, and operating under bylaws.
In addition, the choice of form is influenced by the method of taxation, the goals of the company being established, and the specifics of a particular business, as well as plans to raise external capital, investments by business angels, and venture capital funds.
Corporate governance
In terms of corporate governance, an LLC is an easier form of organization to set up, as it does not require a complex corporate structure, the issuance of shares, annual meetings of shareholders, and minutes of meetings. It can be established by one or more individuals. It is a rather flexible form in terms of company management.
At the same time, corporations are more complex in terms of formation and legal maintenance. This is related to both the issuance of shares and management through the Board of Directors. It requires holding annual shareholders’ meetings and quorums, proper documentation of the results, and informing shareholders about the company’s activities. Therefore, a corporation implies additional organizational requirements and paperwork, etc. Accordingly, this affects the cost of managing and maintaining the corporation.
Business Goals
If a business is owned by one or several individuals who plan to grow organically and do not require outside investment, forming an LLC is often a good choice. LLC members have sufficient freedom in managing the company and can include various provisions in the Operating agreement, a document that defines the management and responsibilities of the members. This organizational form is popular for small, family businesses.
However, if a company plans to attract investment, a C-Corp is generally the preferred structure (as discussed in the taxation section). This form is more attractive to investors because it allows for clear ownership structures, the issuance of different classes of stock, and ease of share transfers. Additionally, C-Corps offer more predictability in taxation, as corporate tax rates apply to retained earnings rather than pass-through taxation. It is also viewed as more prestigious and reliable by banks for financing purposes.
Depending on the type of taxation chosen, a corporation can be of two types: C Corp or S Corp. C Corp provides for the ability to create different types of shares, which gives more flexibility in attracting investments and facilitates the implementation of security solutions for the corporation. For example, it is possible to create a class of shares that gives the right to receive dividends but does not give the right to participate in management decisions. The C Corporation is considered the “gold standard” for startups and tech companies.
Taxation
As a general rule, LLCs are taxed through their members, meaning they are considered pass-through entities. LLC members report the company’s profits and losses on their personal tax returns. As a result, the LLC does not pay corporate income tax; the members are responsible for tax payments. The exception to this rule is when an LLC elects to be taxed as a C corporation.
At the same time, a corporation, as mentioned above, can be taxed as a C Corp or an S Corp:
C Corporation (default taxation type):
Unless the corporation has chosen another form, it is taxed as a C Corp. C Corp taxation can essentially be
called “double taxation” – first, the corporation pays corporate income tax, and then, if it distributes profits to shareholders as dividends, the shareholders must report those dividends on their tax returns and pay taxes.
S Corporation (pass-through entity taxation, similar to an LLC):
From a tax perspective, an S Corp is essentially a pass-through entity, just like an LLC. In other words, the company’s shareholders pay personal taxes on dividends paid, while the corporation does not pay federal income tax. Not every business can qualify as an S Corporation, as there are strict limitations:
- All shareholders must be U.S. citizens or residents.
- The corporation must have no more than 100 shareholders.
- An S Corporation can only issue one class of stock.
Thus, this type of corporation is not advisable for businesses with foreign shareholders (non-US residents) and companies that plan to attract investments through the issuance and sale of different types of shares.
The advantages of LLCs include ease of establishment and further maintenance of the company and taxation, as well as flexibility in management. On the other hand, corporations are attractive to investors, although they require a more formalized approach to establishment, reporting, maintenance, etc.
Additional Considerations When Choosing a Business Structure
When selecting a business entity, consider state-specific regulations regarding LLCs and corporations.
For example:
- In New York, LLCs must publish a notice of their formation in local newspapers, which can cost anywhere from a few hundred to several thousand U.S. dollars, depending on the county.
- It would also be worth paying attention to other organizational forms that are typical for certain industries. For example, for legal or other types of professional activity, it is reasonable to consider an organizational form such as LLP (Limited Liability Partnership).
- Some other states, such as Delaware and Texas, allow the registration of a Series LLC – a structure that enables the creation of separate divisions (“series”) within a single legal entity and in which it is allowed to separate members, assets and operations into separate series. The rights and obligations of these members differ from series to series. Each series operates independently, with its assets and liabilities.
Each series operates independently, with its assets and liabilities. Each entity can enter into contracts or be a defendant in lawsuits, have ownership of property, etc. This structure is commonly used for real estate businesses managing multiple properties.
If you would like to get a consultation on choosing an organizational form for your business, you can reach Ortynska Law via email at [email protected] or by phone at 9147035632.