Corporate Structures for the Newbie

Posted onAuthorLinda Kesselring

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Choosing a corporate structure isn’t just an exercise in paperwork – it determines the company’s tax status, as well as its relationship to potential investors and managers. In this regard, it is one of several key decisions to be made in the early life of your startup. Generally speaking, there are four primary considerations that can guide this decision-making process. These are a) tax requirements, b) access to outside funding, c) level of legal protection, and d) administrative obligations. Below is an outline for a handful of common corporate structures relevant to university-based startups focusing on these elements.

C Corporations
Registering as a C Corp renders the company as an independent entity with its own set of finances and procedures. This offers the strongest protection against personal liability for any of the corporation’s losses, or more importantly, debts, as a C Corp is distinct from its owner-members by design (and a C Corp can have any number of owners). There are, however, administrative requirements that can be complex and expensive, both monetarily and in time-cost. Registering a C Corp often requires a filing fee. There are a number of benefits to registering as a C Corp, however. In addition to allotting common stock to shareholders, C Corps can issue preferred stock that comes with additional terms and benefits. These are usually a key component of financing deals with venture capital firms and angel investors, who want tailored assurances and returns on their investments. C Corps are also designed to facilitate the transfer of stock. However, C Corps are typically seen as being subject to double taxation – as a partial owner, individuals have to pay income tax on any dividends issued and the company itself is subject to various corporate taxes. C Corps are generally eligible for more tax deductions than other business structures.

S Corporations
S Corps are highly similar to C Corps but generally viewed as having a less burdensome tax structure. Any profits or losses recorded by an S Corp “pass through” into the owners’ personal tax returns, avoiding the double taxation quandary. This structure has implications for self-employment taxes. An S Corp, however, lacks many of the provisions that make C Corps so attractive to investors. For one, S Corps are capped at 100 shareholders and business owners must either be U.S. Citizens or residents, eliminating the involvement of foreign investors or other business entities. S Corps also only issue common stock instead of preferred stock as discussed.

Limited Liability Companies (LLCs)
Limited liability companies, commonly known as LLCs, differ from traditional corporate structures in that they provide liability protections to their owners while offering more tax and management flexibility. This means owners can protect their personal finances without needing to submit to the same requirements of a traditional corporate structure. Furthermore, owners can elect to have an LLC treated as a corporate entity, like C Corps are, or as a “pass through” entity, akin to how S Corps are, as it relates to taxes. LLCs are often viewed as a blend between a C Corp and more informal corporate structures and their requirements are meant to be adaptable to the needs of each business. LLCs are usually less preferred for outside investment though as their ownership is dictated by membership interests, which are ownership percentages that allow for a share in profit/decision-making, rather than stock allotment.

 

C Corp

S Corp

LLC
Continuity of life (company duration is not contingent upon original owners) Yes Yes Yes, unless otherwise specified in Certificate of Formation
May award stock to attract investors Yes Yes No
May award membership units to attract investors No No Yes
Owner liability Shareholders have limited liability Shareholders have limited liability Members have limited liability
Upper bound on number of owners No Yes No
Owners must be U.S. citizens or residents No Yes No
Other businesses may assume partial to full ownership Yes No Yes
Owners can list business profit/loss on personal tax returns No Yes Contingent upon elected tax status
Annual board meeting requirements (with compulsory meeting minutes) Yes Yes No
Annual report requirements Yes Yes Yes

 

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