How to Choose the Best Business Structure for Your Startup

How to Choose the Best Business Structure for Your Startup

Key Takeaways

• There are different types of business entities: LLCs provide flexibility and tax choice; S Corps avoid double taxation; C Corps offer growth potential and investor appeal.
• Venture capital firms usually prefer C Corps over LLCs or S Corps because they offer preferred shares, stock options, and a better exit strategy.
• Choosing the best business structure for your startup depends on many factors and requires professional advice.

If you are starting a new business, one of the most important decisions you will make is how to structure your company legally. There are different types of business entities, each with its own advantages and disadvantages. 

In this article, we will compare three common options: Limited Liability Company (LLC), S Corporation (S Corp), and C Corporation (C Corp). We will also discuss which ones are preferred by venture capital firms, and why.

Limited Liability Company (LLC)

An LLC is a flexible and low-cost option for small businesses. An LLC provides limited liability protection for the owners, meaning that they are not personally responsible for the debts and obligations of the business. An LLC also allows the owners to choose how they want to be taxed: as a sole proprietorship, a partnership, or a corporation. 

However, an LLC has some drawbacks, such as:

• Self-employment taxes: The owners of an LLC may have to pay self-employment taxes on their share of the business income, unless they elect to be taxed as a corporation.
• Difficulty attracting investors: Many venture capital firms do not invest in LLCs, because they prefer to have preferred shares, stock options, and a clear exit strategy.

S Corp

An S Corp is a corporation that elects to be taxed as a pass-through entity, meaning that the business income is not taxed at the corporate level, but passes through to the shareholders’ personal tax returns. This avoids double taxation, which occurs when a corporation pays taxes on its income and then distributes dividends to its shareholders, who pay taxes on them again. An S Corp also provides limited liability protection for the shareholders. 

However, an S Corp has some limitations, such as:

• Eligibility requirements: To qualify as an S Corp, a business must have no more than 100 shareholders, all of whom must be U.S. citizens or residents, and only one class of stock.
• Compliance costs: An S Corp must follow the same rules and regulations as a C Corp, such as filing annual reports, holding meetings, and keeping records.

C Corp

A C Corp is the most common type of corporation in the U.S. It is a separate legal entity that can own assets, enter contracts, sue and be sued, and issue shares to raise capital. A C Corp provides limited liability protection for its shareholders, who are not liable for the debts and obligations of the business. A C Corp also has some advantages, such as:

• Unlimited growth potential: A C Corp can have unlimited number of shareholders, multiple classes of stock, and access to public markets.
• Venture capital preference: Most venture capital firms prefer to invest in C Corps, because they offer preferred shares, stock options, and a better exit strategy through an initial public offering (IPO) or a merger or acquisition.

However, a C Corp also has some disadvantages, such as:

• Double taxation: A C Corp pays taxes on its income at the corporate level, and then distributes dividends to its shareholders, who pay taxes on them again at their personal level.
• Complexity and expense: A C Corp is subject to more rules and regulations than an LLC or an S Corp, such as federal and state taxes, securities laws, and corporate governance.

Quick Summary of Cost, Pros and Cons of LLC, S Corp and C Corp:

Corp Type	Cost	Pros	Cons
LLC	Varies by state, typically $100-$500 for filing fees	- Flexible and low-cost option for small businesses - Limited liability protection for the owners - Tax choice: can be taxed as a sole proprietorship, a partnership, or a corporation	- Self-employment taxes: may have to pay self-employment taxes on business income, unless elect to be taxed as a corporation - Difficulty attracting investors: many venture capital firms do not invest in LLCs
S Corp	Varies by state, typically $100-$800 for filing fees	- Avoids double taxation: business income is not taxed at the corporate level, but passes through to the shareholders’ personal tax returns - Limited liability protection for the shareholders	- Eligibility requirements: must have no more than 100 shareholders, all of whom must be U.S. citizens or residents, and only one class of stock - Compliance costs: must follow the same rules and regulations as a C Corp
C Corp	Varies by state, typically $100-$800 for filing fees	- Unlimited growth potential: can have unlimited number of shareholders, multiple classes of stock, and access to public markets - Venture capital preference: most venture capital firms prefer to invest in C Corps, because they offer preferred shares, stock options, and a better exit strategy	- Double taxation: pays taxes on its income at the corporate level, and then distributes dividends to its shareholders, who pay taxes on them again at their personal level - Complexity and expense: subject to more rules and regulations than an LLC or an S Corp

Summary

Choosing the best business structure for your startup depends on many factors, such as your goals, your industry, your size, your location, and your funding sources. Each option has its pros and cons, and you should consult a qualified tax professional or a lawyer before making a decision. However, if you are looking for venture capital funding, you may want to consider incorporating as a C Corp in Delaware, which is known for its business-friendly environment and legal system.

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