What Type of Business Entity Should You Choose?

Joseph Michael Wallin

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Business Attorney

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Posted over 4 years ago. 4 helpful votes

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1

First, You Should Choose an Entity With Limited Liability

When you start a business, you will generally want to protect your personal assets from the liabilities of the business. This means forming an entity under state law--either a corporation, a limited liability company, or under some unusual circumstances a limited liability partnership. In general, you will not want to do business through the unincorporated partnership form or as a sole proprietor because then your personal assets will be subject to the liabilities of the business.

2

What Type of Limited Liability Entity Should I Choose?

Whether you choose a corporation or an LLC will depend on a number of factors, such as: (1) how many owners will the business have at the outset, (2) whether you plan to bring on new owners on a regular basis, (3) whether you want to grant stock options or similar equity incentives to service providers, (4) whether the entity be wildly profitable and a cash cow or will profits be reinvested to grow the business, (5) how you plan to finance the business, and (6) the exit plans for the business (IPO or sale). If the business is just going to be owned by you, and you don't plan to bring on new owners or offer equity incentives, and you intend the business to be a cash cow, the LLC may be your best choice (although an S corporation may have tax advantages). If the business is going to have multiple founders, be funded through venture capital, offer equity incentives to employees, and hopes to be sold to a big industry player--then a corporation is probably the best choice.

3

Will Third Parties Invest as Passive Equity Investors?

If you plan to raise equity capital from passive third party investors (meaning, investors who will not be actively involved in the business), then you will probably want to form as a C corporation. The reason for this is because most passive equity investors do not want to receive a Form K-1 and have to report income or loss of the business on their personal tax return (and a Form K-1 comes along with both LLCs and S corporations).

4

S Corporation or C Corporation?

If you have decided that you want to form your business as a corporation, you may want to consider electing to have the business taxed as an S corporation. An S corporation is a corporation that has elected to have all of its income or loss taxed to its owners, and not to the entity. So, the entity itself is not a taxpayer. The entity's shareholders pay the tax on the business's income. Not all businesses are eligible to make an S corporation election, and even if eligible you may not want to make the election. Whether you want to make the election is going to depend on whether you want the income or loss of the business to be taxed to the owners or the entity itself. An S corporation can be a good choice for founders who are going to fund the business's losses in the early years and are going to be actively involved in the business. There are drawbacks, however--e.g., the losses may not be fully deductible and QSB stock benefits will not be available for the founders' stock.

Additional Resources

http://www.startupcompanylawblog.com/articles/choice-of-entity/

Choice of Entity

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