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Should You Form a Corp or an LLC?

177130937The following is a guest blog post by April E. Frisby of Newmeyer & Dillion in Newport Beach, California. Her practice includes securities, business transactions, corporate law, and estate planning. April provides advice on capital formation, business strategy, and legal matters to entities and business professionals.

A question I am often asked by clients and practitioners alike is: Should I form a corporation or a limited liability company (LLC)? The answer depends on several things, including investment considerations, tax issues, and management preferences.

Whether you go for a corporate or LLC business structure, you’ll have to deal with many corporate formalities and an $800 minimum franchise tax bill, so the first thing to consider is whether an entity (as opposed to a sole proprietorship or partnership (limited partnerships are beyond the scope of this post)) is appropriate at all. Among other things, generally speaking, legally formed entities provide limited liability for owners, enjoy certain tax benefits, may be more attractive to private and institutional lenders, and may make the business appear more prestigious.

Once you’ve determined that forming an entity is the right way to go, then you need to choose a business structure. Here are some key issues to look at when deciding between a corporation and an LLC:

  • Attractiveness to investors. A corporate structure may be preferable if the business intends to seek many outside investors (the corporation can offer different classes of preferred stock, pay dividends, etc.), plans to go public, or wants to attract more conservative financing (i.e., bank loans).
  • Tax benefits. A corporation has two levels of taxation (i.e., the shareholder and corporate levels) unless it elects S Corp. status, which has its own requirements (i.e., no more than 100 shareholders that are all individuals or certain trusts and estates, no nonresident aliens as shareholders, only one class of stock). But a C Corp. might be the right choice instead because of certain corporate deductions on fringe benefits it allows. By contrast, an LLC has “pass through” taxation to its owners. In my experience, the accounting for an LLC can be more flexible (most multi-member LLCs are taxed as partnerships), but it’s also more complicated (hint, hint—you need a good CPA!).
  • Management options. LLCs can be more flexible about management: Corporations use boards to set the corporate agenda and officers to run the day-to-day operations while LLCs can be run by the owners (members) or by an appointed outside manager.

How these issues are decided is dependent on the goals and expectations for the business entity. Is the plan to go public or to run a one-person show? Going public is best suited for a C-Corp., as it can allow for numerous and foreign investors. But the flexibility of an LLC may be better suited for a small independently-run business.

And regardless of the type of entity chosen, remember that forming a legal entity is only part of the solution: You must observe certain corporate formalities such as annual shareholder and board meetings and issuing stock certificates for a corporation or adopting an operating agreement and issuing membership certificates for an LLC to preserve limited liability status, among other things.

For help choosing the perfect business entity for your client and learning how to organize it, turn to CEB’s Selecting and Forming Business Entities. Also check out CEB’s program Choosing the Right Business Entity, available On Demand.

Other CEBblog™ posts you may find useful:

© The Regents of the University of California, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

2 Responses

  1. One key issue with the California LLC is “capital accounts”. Each “member” (investor) gets a separate capital account which has to tracked year to year for tax purposes, rising and falling with allocated losses and profits. Once you get beyond a few members, keeping track of lots of uncoordinated capital accounts quickly becomes a paperwork nightmare. For this reason, I’ve learned to restrict LLCs to small groups of investors. An LLC is ideal for a single or 2-3 person operation. It’s fantastic as a vehicle to hold real estate. Because of the capital account issue, it is often a mess for a startup that intends to grow through taking on outside investors.

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