When launching a startup or other company, it is critical to choose the right corporate entity structure at the onset. Corporate entity structures can include limited liability companies, corporations, limited partnerships, and others. Determining how to register a company has significant business implications. The decision can impact how much in taxes the entity must pay and the scope of business that it can conduct. There are different roles for officers and directors, the dangers of liabilities, and a host of other issues central to business transactions.
Due to the state’s favorable corporate governance regulations, most corporate entities register in Delaware. We will outline some of the key types of business forms that startups can choose from, as well as their consequences.
Corporate Structures: C Corps and S Corps
There are two types of corporations: C Corps and S Corps. Under Internal Revenue Service (IRS) rules, the C Corporation is the default type of corporation. C Corporations are taxed under Subchapter C of the Internal Revenue Code, whereas S Corporations, which benefit from special tax status, are taxed under Subchapter S of the Internal Revenue Code.
C Corps are usually the preferred corporate structure for raising venture capital financing. This is because there are typically multiple classes of stock in a VC or angel-backed company, which the S To set up a corporation, you must submit articles of incorporation to the state, draft bylaws and the necessary resolutions to open an account at a bank, and obtain an Employer Identification Number from the IRS. Corporations must have at least one director and two officers (president and secretary). Directors can be officers and vice versa, so you need only two people. structures does to not permit.
To set up a corporation, you must submit articles of incorporation to the state, draft bylaws and the necessary resolutions to open an account at a bank, and obtain an Employer Identification Number from the IRS. Corporations must have at least one director and two officers (president and secretary). Directors can be officers and vice versa, so you need only two people. structure. Since early-stage startups typically incur significant losses, a risk of double taxation is unlikely for a while. In addition, once the company becomes profitable, different structures will probably be implemented for distributing the profits.
The main drawback to a C Corp structure is the potential for double taxation. C Corps file a corporate tax return on Form 1120. There is also a possibility of personal taxable income if the corporation distributes income to business owners as dividends. Thus, the corporation pays taxes at two levels: first at the corporate level and then at the personal level when the corporation declares dividends.
S corporation structures offer significant tax advantages and are useful if you are not planning to raise any venture capital or angel investor money. S Corps come with the tax benefits and flexibility of a partnership, namely avoidance of double taxation risk. Partnerships benefit from only a single level of taxation. Meanwhile, S Corps also retain the liability protection of a C Corp.
Limited Liability Company
A limited liability company (LLC) has similar legal characteristics to an S Corp. One key distinction is that LLCs use membership units, rather than stock options. This makes it considerably more difficult to effectively grant equity to employees. LLCs are the better choice for companies with a limited number of owners. Corporations are better when many people are owners as stockholders.
A limited partnership (LP) consists of at least one general partner and one limited partner. The limited partners enjoy limited liability. In other words, the limited partners liability is confined to the amount they put into the business. Limited partners do not involve themselves in the day-to-day management of the business.
General partners are involved in running the business, but they have unlimited liability. In other words, within these structures, they are responsible for any debts of the company, even in amounts exceeding their initial investment. A LP entity enjoys pass-through taxation. They are able to avoid the double taxation typical of C Corporations.
Limited Liability Partnership
A limited liability partnership (LLP) is generally only for lawyers, architects, and accountants. In an LLP structure, some or all partners are able to reduce their liability for the actions of other partners. Specifically, each partner’s liability is limited to the amount they put into the business. If the partnership were to fall apart, creditors would not be able to go after any partner’s personal assets. LLPs enjoy similar pass-through tax benefits like ordinary partnerships.
Foreign Business Structures
Corporate structures vary by country. Many jurisdictions have entity structures with similar characteristics to C corporations, partnerships, and LLCs.
One legal entity common in Germany, Austria, Switzerland, and Liechtenstein that has many parallels with the limited liability company (LLC) is the GmbH. The acronym “GmbH” is short for the German phrase “Gesellschaft mit beschrankter Haftung”, which translates to “company with limited liability.”
Another common foreign structure in Germany and surrounding countries is the AG. The abbreviation “AG” is short for the German word “Aktiengesellschaft”, which is a public company traded on a public stock exchange. Some familiar examples include Volkswagen AG, Daimler AG, and BMW AG.
The public limited company (PLC) is a type of public company in the United Kingdom and certain Commonwealth countries. In many French-speaking countries, the Société Anonyme (SA) is a common structure. This is the equivalent of a corporation in the United States and a public limited company in the United Kingdom.
In the U.K., Ireland, and Canada, the “Ltd.” company structure protects shareholders’ personal assets from liability. This private limited company structure provides separation of the company’s financial assets from the personal assets of its shareholders. In many French-speaking countries, the S. à r.L. (Société à responsabilité limitée) is the equivalent to the British limited company (Ltd.) or the American limited liability company (LLC).