Typically, you’d use the LP when one partner takes more control, and therefore more responsibility, over the startup’s direction and finances. ~ Scott Lieberman, Touchdown Money
What is one business formation option for a startup? What are the pros and cons?
To help determine which formation option is right for your startup, we asked startup founders and legal professionals this question for their best insights. From forming a Limited Liability Company to setting up a C-Corporation, there are several startup formation options with their pros and cons that may help you make an informed decision in setting up your business.
Here are seven business formation options for startups:
- Form a Limited Liability Company
- Start as an S-Corporation
- Form Company as LLC But be taxed as an S-Corporation
- Bootstrap Basic Legal Requirements
- Select Options Based on Type of Service
- Choose Limited Partnership or Limited Liability Partnership
- Set Up a C-Corporation for Its Benefits
Form a Limited Liability Company
Forming an LLC is the smartest way to start as a new business. This is assuming you are like most normal start ups and have between 1-10 employees and less than say $250,000 in the bank. An LLC will allow you to not put your personal assets at risk like your house or car if something were to go wrong and litigation happens. You can pass through all the corporate profits to the owners who will pay the taxes themselves so the corporation doesn’t have to pay federal taxes on its profits. They are easy to maintain and the paperwork is minimal and easy to file online yourself. The cons are that you will have to pay your own self-employment taxes, and the corporate veil can be pierced in certain cases such as fraud.
Ben Walker, Transcription Outsourcing, LLC
Start as an S-Corporation
Startups can be S-corporations. In this model, the shareholders own the company, but they elect decision-makers for the daily operations. Like an LLC, an S corporation protects the shareholders’ assets. Since revenue and losses are reported through each shareholder, S corporations aren’t double-taxed. However, there are also disadvantages. S corporations have to pay annual fees, and there are restrictions regarding who can be a shareholder, and there is only one form of stock.
Justin Soleimani, Tumble
Form Company as LLC But be taxed as an S-Corporation
For the last couple startups I have launched, I have applied the same playbook for formation purposes: I form the entity as an LLC, but elect to be treated as an S-corporation for tax purposes. This has two benefits. The first is flexibility in ownership. S-corporations are highly restrictive in terms of capital injections and withdrawals as owners – you generally can’t make special allocations outside of the fixed ownership percentage. By contrast, LLCs allow tons of flexibility in how you want to allow members to contribute capital and take distributions. You can make special contributions/distributions outside of normal percentages. The flip side, however, is that LLCs are tax disadvantaged compared to S-corporations. All LLC member distributions are hit with employment taxes (FICA), while S-corp owner distributions are not. Thus, by electing to operate as an LLC taxed as an S-corp, you get the best of both worlds: flexibility in ownership and no employment tax on distributions.
John Ross, Test Prep Insight
Bootstrap Basic Legal Requirements
The first phase of forming a company revolves around addressing basic legal needs. Hiring and working with a law firm to process legal documents is quite pricey. It might be beyond your budget because startups typically don’t have enough venture-back capital to cover pre-operating costs. As an alternative, you can bootstrap your business by consulting lawyers at a cheaper fee just to guide you in making legal decisions. You can also do thorough research by using the internet to find legal references for free. That way, you will no longer have to apply for a business loan for additional funding, relieving you from a potential long-term obligation.
Allan Stolc, Bankly.dk
Select Options Based on Type of Service
Your legal status as a business owner is important to your success. Setting up your business effectively can provide more opportunities, but will also provide more liabilities. The most important factors include your business goals and level of investment. Some options may make sense for certain businesses, but not for others. For example, if you’re planning to sell your products or services for a profit, then a state business license may be necessary. However, if you’re planning to be a sole proprietorship or a partnership, you would not need a business license. If your business takes a lot of capital to start, forming a corporation may be a good option for your business. As a corporation, your business would exist separately from you as an individual. A corporation would have its own identity and would have its own tax identification number. Corporations also have lifespans, so if your business goes under, there are laws in place to protect you.
James Scott, OzBox
Choose Limited Partnership or Limited Liability Partnership
The LP, limited partnership, or LLP, limited liability partnership, are great options for startups with multiple founders looking to get their business off the ground. With limited partnerships, one partner holds unlimited liability while the other partners are limited, while the LLP gives every partner equal limited liability. Typically, you’d use the LP when one partner takes more control, and therefore more responsibility, over the startup’s direction and finances. The LLP protects each partner equally from the debts of the partnership. Though your startup may one day grow beyond the partnership phase, the LP and LLP help entrepreneurs work together toward a common goal and test their business ideas within a less formal business agreement.
Scott Lieberman, Touchdown Money
Set Up a C-Corporation for Its Benefits
The C-Corp is one business option. This is usually best served by larger companies because it causes you to be double taxed. The corporation is first taxed on profits and then you are taxed on your dividends. Another disadvantage is creating this type of structure is a paperwork nightmare. You will need an accountant and an attorney to handle it. The advantages are that you are not personally liable for any company losses and you are more apt to gain investors with this type of structure. Investors like the C-Corp structure because it lessens liability. It is the type of structure you need if you are seeking heavy-hitting investments for equipment, expansion, or government contracts. This is the most popular type of business structure in the United States and it allows companies to be publicly traded on Wall Street. Companies like Apple and Intell are C-Corps.
Tanya Klien, Anta Plumbing