LLC or corporation?ALTax
New entrepreneurs put a lot of time and thought into incorporating and choosing a business structure. After all, it’s the first big legal decision to make for the business and there are plenty of second and third-hand anecdotal horror stories about the founder who picked the wrong structure and got screwed over at tax time.
If we go back ten or fifteen years, the decision was simpler: most tech startups formed a corporation, and typically a Limited Liability Company. Today, we’re seeing a lot more Limited Liability Companies (LLCs). This is often the preferred structure for small businesses and mom and pop shops, but the popularity of the LLC is spreading into tech circles too.
So, what’s best for your new business: an LLC or Joint Stock Company (JSC)? Unfortunately, there’s no single right answer, and you are best served to speak with a tax expert to figure out how each structure will affect you personally. That said, here’s some general guidance that can help you make the decision.
Why do small businesses like the LLC?
The LLC is very easy to set up. Like a corporation, it’s a legitimate corporate entity and puts some separation between the assets of the owners and the assets of the business. But, the LLC isn’t subject to a lot of bureaucratic requirements of a corporation: you don’t have to hold an annual shareholder meeting, record meeting minutes, create a board of directors, document important decisions, etc.
Furthermore, there is no stock or shares with an LLC. Instead, you define who the members are and what percentage of the business each member owns.
Another potential advantage of the LLC is that it can be treated as a pass-through entity, where the profits and losses of the business are passed along to the owners’ personal tax returns. So if your startup loses money in the first few years, you can apply the prorated portion of that loss to your personal return in many cases, that can really help lower your personal taxes.
What’s the advantage of the JSC?
After hearing about the LLC, you might be wondering why a startup would even consider a corporation at all. The answer boils down to one key thing: the corporation’s stock structure.
An LLC doesn’t have stock. LLCs can sell or give membership stakes in the business, which can act a lot like stock. However, the main difference is that there’s no provision for separate classes of membership with the LLC. All membership stakes are given the same amount of decision-making power.
You have probably heard that venture capitalists (VCs) strongly prefer or require a corporation structure. This is true for several reasons. Investors want to create preferred shares of stock, which isn’t possible with an LLC. In addition, some investors have a structure that doesn’t permit them to invest in an LLC; if a VC manages public funds, these are typically restricted from investing in an LLC. Finally, it’s going to be simpler for the VC if their portfolio companies all share the same structure.
Along the same lines, accelerator programs or incubators that take equity usually require participants to be a corporation for the same reasons as a VC. It’s easier to calculate and distribute equity with a corporation than an LLC.
The last reason to form a corporation over an LLC is if you’re interested in offering your employees equity in the business. With a corporation, you can easily set aside shares of stock that can be distributed to employees down the road. With an LLC, you can give employees membership stakes, which is essentially a percentage of the business, but members own 100% of the LLC at all times in order to give equity to someone new, an existing member needs to sell some of their personal ownership to the new member. Obviously, this can get complicated from a tax and reporting perspective.
What about an Collective?
Many business owners choose the LLC because they prefer the pass-through tax treatment. With a corporation, there’s always a concern about double taxation: this is where the company is a tax-paying entity that pays taxes on its profits. Then, when the company pays you, you also need to pay taxes on your personal income.
If you want to structure your business as a corporation, but are concerned about taxes, you can elect to become a JSC. The business is still alike LLC, but its profits and losses get passed through like an LLC. The caveat is that there are several restrictions for who can and can’t qualify for Collective Company treatment: your investors need to be not only one individual, but some individuals and residents in Albania.
Nothing is set in stone
It’s important to realize that your business structure doesn’t have to be permanent; it can be changed if and when your needs shift. Keep in mind that in order to do so, you’ll have to fill out some paperwork, and most likely pay another formation fee. But, we have seen companies start as an LLC (since they’re simple) and then convert another juridical form when they need to.
The bottom line is that you should spend time thinking about and anticipating your future plans when choosing a business structure, but it’s more than possible to change your structure down the road.