Choosing the Right Entity for Your Startup: LLCs
Updated: Jun 11, 2020
LLCs are arguably the most popular business entity in Oregon today, largely due to their ease of setup when compared to corporations, and their highly customizable nature. While LLCs have many advantages, they are not the right choice for every application. In the following article, we’ll discuss the advantages and disadvantages of LLCs.
LLCs offer several key advantages over corporations. LLCs are, seemingly, easier to set up and maintain when compared to corporations. LLCs do not have as many ongoing corporate formalities that owners must follow on a regular basis, such as annual shareholder meetings required for Oregon corporations. Pass-through taxation is another benefit. An LLC with multiple members or owners is taxed as a partnership by default, with each member reporting his or her share of profits and losses on a personal income tax return.
Pass-through or partnership taxation can be advantageous in certain contexts, such as for small family-owned businesses that are not seeking outside investment. LLCs also have significantly more flexibility when it comes to defining management structure. Founders using an Oregon LLC can create management structures similar to partnerships where all owners have the ability to participate in running the company, or LLCs can be setup to parallel the structure of corporations with owners electing officers to manage the company. Management flexibility and pass-through taxation are two of the biggest LLC advantages.
The general consensus is that startups looking for outside funding or venture capital should be established as a C-Corporation rather than an LLC. In a nutshell, this is because of the tax implications for investors, and the predictability corporations provide. Partnership taxation noted above is problematic for outside investors, because they are required to recognize income and pay taxes on it even when the company is reinvesting all profits back in to the company.
Corporations have been around for a long time, and LLCs are the relative new comer. Where the first American corporations were developed in the late 1700s, LLCs only began popping up 1977. With that long history, there is a well-developed body of law and many precedent cases insulating shareholders of C-corporations from being held liable for the business’s actions (the “corporate veil”). While there are similar protections for LLCs, there are far fewer case precedents, and thus potentially more risk that shareholders could be held personally liable for wrongdoings of the business.
C-corporations have conventional structures in place for distributing and issuing different classes of stock, and investors typically seek preferred stock. While LLCs can grant “units” in the company and set up preferential rights similar to preferred stock, this can easily become complex and costly as there is no conventional model for implementation, and investors will not immediately be familiar with that new structure.
With the forgoing in mind, here is what I hope you can take away form this piece: If you are a venture-bound company with your eye set on growing quickly and seeking outside investment, you should avoid LLCs and go for a C-corporation instead. On the other hand, if you do not plan to seek outside investment and will run a small, local business, you may find LLC tax treatment and management flexibly to be just the right fit.
If you are thinking about starting a business in or around Portland, Oregon or are interested in learning more about choosing the right business structure, contact us.