Starting My Own Business

What Type of Business Entity Should You Form?

Written by James Garvin for Gaebler Ventures

Knowing which kind of business entity to form when starting your business is a critical decision that leaves many entrepreneurs scratching their heads as they try to understand the pros and cons and requirements for each entity. Below is a summary of the pros and cons of the core business structures.

There are 5 main entity structures that you can choose to organize under, all of which their own unique requirements and I have summarized the pros and cons of each one below.

1. C Corporation

C Corporations were historically popular with startup companies planning on raising venture capital. However, the flexibility inherent in LLCs has greatly reduced the number of startups that opt to form a C Corporation.

Pros:

• Personal liability protection (you are not personally liable)
• Easier to raise outside funding by selling "shares"
• Can register in more tax-friendly states such as Delaware or Nevada
• "Shares" are often more liquid (easier to sale) than ownership in an LLC or LLP.

Cons:

• Costly to start, run, and terminate
• Requires more organized record keeping to stay compliant
• More complicated tax requirements
• Requires an independent Board of Directors (may be a pro if you need advisors for your business).

2. S Corporation

Making an S-Corporation election on a C Corporation allows the corporation to pass through taxation to shareholders rather than paying corporate taxes. This simplifies tax filing, and as a result this is a popular legal entity type for startups.

Pros:

• Pass-through taxation (lower corporate tax rates)
• Same liability protection as a C corporation
• Similar benefits to a C Corporation

Cons:

• Not attractive to outside investors
• Can only have one class of stock
• Time consuming to manage

3. Limited Liability Company ("LLC")

This is by far the most popular entity type for new startups, primarily because of the flexibility it provides on numerous fronts.

Pros:

• Easy to set-up and manage compared to a C or S corporation
• Often cheaper to set-up and manage then a C or S corporation
• Allow for multiple owners (members) and managers
• Liability protection like a C or S corporation
• No double taxation like a C corporation

Cons:

• Some states (California) require a high minimum tax be paid, even if no income is generated.
• Requires an operating agreement among its owners/members
• Income loss can flow through to the owners/members
• Not attractive to outside investors
• Less liquid than a C corporation where shares are held. More difficult to sell your ownership in an LLC. C corporations allow you to sell your common stock shares, but LLC's often do not have common stock for sale.

4. Limited Liability Partnership ("LLP")

An LLP is similar to an LLC and most commonly used by professional organizations such as law, consulting, and medical firms where "partners" share in the profits/losses of the partnership.

Pros:

• Easier to set-up than a corporation (similar to an LLC)
• Liability protection like a C corporation with out the hassle and cost of managing a C corporation
• Partners may not be held responsible for the action of the other partners.

Cons:

• Partners can be held personally responsible for company's income losses (pass-through taxation).
• Some states do not recognize LLP's

5. Sole Proprietorship:

This legal entity type is perfect for companies with a single founder or single employee.

Pros:

• Easy to register and set-up
• Limited record keeping requirements
• Business losses can be deducted from your personal income which can help lower your tax rates.
• Limited legal requirements and a lot of flexibility

Cons:

• You can be held personally liable for accidents or mishaps
• Difficult to raise outside capital under this entity structure
• No business partners to help you grow your business
• May still be required to file a fictitious business name

James Garvin began his education studying biotechnology. In recent years he has turned his interest in technology to helping two internet startup companies. The first business was an online personal financial network and the second was an e-marketing platform created to help entrepreneurs demo their web sites. Currently a student at University of California Davis, James is spending his summer incubating two new online businesses and writing about his entrepreneur experiences.

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