[Video & Enhanced Transcript]
Today’s topic: should I form an LLC (limited liability company) or corporation for my new business? The short answer: both can be the right choice, depending on what you want to accomplish. LLCs are the most popular entity choice available, including when compared to corporations. But corporations do have their advantages. In this video, we’re going to address the high points of the discussion.
Brief Mention of Other Entity Types
I should also point out the many other entity structures available aside from LLCs and corporations. You could form a sole proprietorship, a partnership, a limited liability partnership (LLP), or limited partnership (LP). Each has its pros and cons.
Sole proprietorships and partnerships have more cons than pros; usually you won’t choose either of those two options. Better to run your business through a limited liability entity of some type, such as an LLC or corporation.
In this video, we’re going to focus exclusively on LLCs and corporations, because of their relative popularity.
Let’s start with corporations and their advantages:
- Advantage 1–Entity Shield. Corporations have a very strong liability shield for their owners. In fact this is the main reason you see so many well established corporations. When the corporate entity structure first came into existence, it was the only way to create an entity shield of this type. At that time, if you wanted to protect the business owners’ assets and only expose the business’s assets, you formed a corporation.
- Advantage 2–Big Dogs. The corporate structure is what the big boys use. If you want to be like a Microsoft or Boeing and go public, then you want to form a corporation. Similarly, if you want to associate with the big boys—if you want people to think you’re big even though you might not be—then perhaps you’ll want to form a corporation rather than an LLC.
But as I mentioned, there are several disadvantages inherent to corporations:
- Disadvantage 1–Double Taxation. If you form a corporation the way the big boys do, you subject yourself to double taxation. There is taxation both at the corporate level and at the individual level. So most people won’t want to form a business exactly like Microsoft or Boeing. Instead, people who form corporations will at least initially choose to be taxed under the S corporation election. That results in a single level of taxation. But you can only make an S corporation election while the business is closely held, and there are other restrictions.
- Disadvantage 2–Inflexible Hierarchy. I think the biggest reason why people might choose not to form a corporation would be the inflexibility of the corporate structure. Corporations will always have a board and executives, and that can be a cumbersome way to do business. Most people would prefer to run their businesses in ways more akin to a sole proprietorships or partnerships because of the ease in making decisions.
Next let’s look at LLCs (limited liability companies). Some people say “LLCs are the best of all worlds.” I can’t agree entirely, but there are many advantages:
- Advantage 1–Same Liability Shield. LLCs provide their owners with a liability shield equivalent to a corporation’s. That’s unique among the other entity types available. Only LLCs and corporations protect the owners assets to the greatest extent possible.
- Advantage 2–Taxation. LLC’s provide the most flexibility in taxation—even more flexibility than a corporation. So if you’re trying to save on taxes, an LLC might be a good choice. But, ultimately, most LLCs make an S corporation election, which means there tends to be little to no practical difference in taxation between the entities we’re comparing.
- Advantage 3–Flexible Hierarchy. The biggest reason for forming an LLC is the flexibility of the structure. You can structure an LLC’s decision-making hierarchy almost any way you want, including in ways similar to a sole proprietorship or partnership. That’s what most people want to do.
The primary disadvantage of an LLC is that it isn’t what the big boys use. If you want to go public or associate yourself with the biggest companies, then perhaps an LLC isn’t the best choice for you.
Bottom line: an LLC is the better choice for most people and their businesses. But a corporation might be the better choice if:
- You want to go public. Maybe you’re not ready to do it now, but you intend to do it in the future; or
- You want to associate yourself with the big dogs, like Microsoft and Boeing.
I should add, you can initially form an LLC and then convert it to a corporation at a later date. That might be how you can truly gain the “best of all worlds”.