Dave, we’re trying to figure out, should we set up our business as an LLC or S-Corp? In particular, an LLC Corporation instead of an LLC partnership, though we have heard from a few people that a partnership LLC is best. What’s the difference and what works best with three — unequal ownership — founders?
First of all let’s clarify the terms. There is not such entity as a LLC Corporation. The proper name for LLC is Limited Liability Company and the origins of this entity are based on partnership law. In the early years of LLC’s most states required two members. Today in many states including Colorado you can file a single member LLC. There are good websites that compare the differences and they are too numerous to cover in this response. Just search “llc versus corporation”. My focus will be to get you to ask the right questions. I’ll take a more practical approach.
Okay, now the first thing you should decide is what your funding strategy is. If you are going to become the 1 in 4,000 businesses that will secure venture funding then I personally would recommend a Delaware Corporation. Here is a good perspective from someone who knows. This would be the best entity to structure and I would advise getting an expert opinion or legal advice on how to set up your capitalization tables. Delaware charges a franchise fee based on the number of shares you authorize and your book value. So you can easily end up with a fee of a few thousand per year just to have a Delaware Corporation. As a comparison Colorado charges a flat $50 to file online.
If you are going to have a few owners and you do not anticipate the need to raise external capital then the LLC is a fine way to go. You should understand though you will need to draft up an operating agreement to make the company legal. This document acts in a similar way as the Bylaws of a corporation. Prior to filing your articles of organization you will have to decide whether or not you are going to be a member managed or manager managed LLC. There is one interesting risk that is often over looked and that is if you sell the LLC it is possible you will have a larger tax bill based on how you distribute the proceeds than if you were a corporation.
Now a S-corp is legally the same as a C-corp the only difference is you will file a 2553 election with the IRS. This gives you a different tax treatment than a C-corp and it also has restrictions. The main ones are that you can have no more than 100 shareholders and only one class of stock. You also will have to keep corporate records and this means keeping minutes and having an annual shareholders meeting. Actually in my opinion I prefer to keep track and document key decisions that affect my companies. You can buy a corporate book from Blumberg Excelsior I recommend the Black Beauty. This sub $100 investment will help you keep all of your corporate documents in one folder.
Ultimately you have to decide what is best for you and understand every attorney, CPA and current entrepreneur has their own bias based on what they have typically done. For me I’ve set up LLCs, S-corps, C-Corps and Delaware Corporations. It really depended on what my plan was for each company.