As a Colorado Business Startup Lawyer at LaszloLaw, choosing the structure of your business is an important first step for any business startup. There are many forms your startup can take but, in reality, there are only three forms a startup will consider: C Corp, S Corp, or LLC. Deciding what corporate form a startup should take is one of the most critical early decisions a startup will make. But, making an informed decision and laying the proper foundation will save many headaches down the road.
The C Corp: The C Corp is a separate legal entity and is a separate tax payer, i.e., it pays its own state and federal taxes and if it distributes dividends to shareholders, those dividends are taxed (and paid by the shareholders). This is commonly referred to a “double taxation.” But does it make sense for a startup to organize as a C Corp? Maybe … maybe not. The most important scenario for startups to organize as a C Corp is where it plans on raising venture capital – in this instance it has to be a C Corp. Another reason to be a C Corp would be where the startup plans to retain money in the company.
The S Corp: If you are not sure whether your startup will need to be a C Corp down the road, but it remains a possibility, the S Corp offers very good flexibility and can be easily converted to a C Corp should the need arise. Perhaps the most attractive feature of the S Corp is the pass through taxation and ease with which it can be converted back to a C Corp (I say “back” because you first organize as a C Corp, then elect S status by filing Form 2553 with the IRS). There are key drawbacks to the S Corp however. An S Corp must adhere to all C Corp formalities including recordkeeping, shareholder meetings, file annual reports, etc. Also, S Corps cannot have more than 100 shareholders – which would essentially eliminate the possibility of crowdfunding – LLCs cannot be shareholders and all individual shareholders in an S Corp must be US citizens or permanently reside in the US. Finally, the S Corp is far less flexible in terms of division of profits and classes of stock – for example, as an S Corp, your startup cannot have common and preferred classes of stock.
The LLC: Which brings us to the darling of the small business world – the LLC. If your startup does not plan to raise venture capital and seeks flexibility in ownership structure, the LLC is a very desirable corporate form. Like the S Corp, the LLC provides for pass through taxation and will protect personal assets from liability (when corporate formalities are observed). One of the most convenient aspects of the LLC is that owners of an LLC operate the business pursuant to an “Operating Agreement.” Please do not mistake this to mean an Operating Agreement is a simple document – generally, they are not. However, LLC Operating Agreements can be drafted to address very specific items unique to a given business’ needs. Further, division of profits and losses are easily dealt with in the LLC – whereas in an S Corp, any division must strictly conform with one’s percentage ownership of the company. It is important to note that not all states permit conversion of an LLC to a C Corp – thus, an LLC may not be the best option if you need to be a C Corp down the road.
The above is a very general overview of the three main types of corporate structures utilized by startups. It is paramount that any startup fully understands its current position with an eye toward the future when deciding what form to take.
Colorado Business Startup Lawyer
Contact a Colorado Business Startup Lawyer at LaszloLaw for legal counsel for your startups, for-profit, and non-profit businesses on a variety of business needs, including corporate formation; risk management; corporate protection; and legal compliance. Contact us today so we can help address the needs of your business.