Question

1. Why start-up companies have to choose LLCs and Corporation style.

2. Then why this is so important for start-up companies?

3. Also, how their decisions could make impact their companies in the future?

Answer 1

Answer 1.

Startup: Startup refers to the company in its initial stage of operation, founded by one or more entrepreneurs on a very unique and disruptive idea aimed to provide solutions to real-world issues. It is a new company and provides a unique product or service that has a lot of demand in the market. A startup is different from a small business, a startup should have a disruptive and unique business idea that can solve real-world problems.

The startup is a risky proposition and should have a proof of concept to attract more investors and customers to the startup.

There are multiple types of formation of a new business that is listed below,

a. Sole Proprietorship

b. Limited Partnership (LP)

c. Limited Liability Partnership (LLP)

d. Limited Liability Company (LLC)

e. Cooperation - C Corporation, S Corporation, B Corporation.

A startup company can choose either Limited Liability Company (LLC) and Corporation. We will discuss the multiple advantages a startup can get from these methods of formation,

1. Limited Liability Company (LLC): This is not a traditional formation style this is a modern formation method that was allowed recently in most of the states.

Limited Liability Company is a hybrid style of a company formation where the owners or founder would not have personal liability for the company's debt or any other liability. An LLC structure protects from personal liability and provides legal protection of personal assets and pass-through taxation. It is one of the simplest business formations than a corporation but more legal structure than proprietorship and Corporations.  

Advantages of formation as LLC:

There are many advantages provided by the formation of LLC for your startup. We will discuss the main advantages in the below points,

a. Avoid double taxation: This is one of the main advantages of LLC formation. LLC provided the owner to avoid double taxation for business and for self but have multiple classes of stock. A corporation will have two types of taxes, one for organization and second for the owner himself. But an LLC formation will remove this burden. In the future, if need, we can convert our business formation from LLC to Corporation anytime with a simple procedure.

b. Protect personal Assets: An LLC formation will allow founders to protect personal assets against business debt and other losses. It is better than a sole proprietorship as in proprietorship, the owner will have the complete liability of the business and other parties can claim their debt and losses against owner personal assets. But LLC solve this issue and protect their personal assets from business losses.

c. Easy Registration: An LLC is simple and less complex in registration with legal authorities. It is faster than a corporation in terms of legal formalities and restoration process. We can register an LLC without an attorney.

d. Easy Compliance: An LLC is easy to maintain and provides less compliance filling as per the legal requirements. It is a middle form of a sole proprietorship and a corporation.

2. Corporation:

A corporation is a legal entity that separates owners from its business entity, which means the business has separate from owners in terms of rights and legal liability. This is an advanced form of a business structure and gives you the option of various types of stocks that can be divided into its directors and investors according to their roles and investment in the startup.

In the eyes of law, a corporation is a separate legal entity that has many rights as an individual, such as this entity can enter into contracts, can buy, sell, or own assets, can employee people, can sue, or can be sued.

Advantages of formation as a Corporation:

There are many advantages of a corporation for startups, these advantages are listed below:

a. Limited Liability: Corporation provides its owner a limited liability option to its shareholders which means the shareholder has no personal liability or responsibility for the debt of the corporation. That means the creditors have no right to claim on shareholder's personal assets for their debt or losses.

b. Provide Credibility: When it comes to investing money by the investors (angel or VCs), they prefer to invest in a startup that has a formation style of a corporation because they will get corporation shares and in future, they get their return on investment by selling the shares they hold in the corporation.

c. Transferability of ownership: Unline proprietorship or partnership, the ownership in a corporation can easily be transferable to other shareholders or investors.

d. Raising capital: Financial or non-financial investors invest money in a corporation business only because they can hold company shares according to the valuation of the company.

e. Attract talented employees: It is the perception that a corporation has a stable business because of more capital, more talented top management, and leadership, and legal structure. So it can attract more talented employees to the corporation and the corporation can provide stock options that the employee can be benefited in the future when they sell their stock.

f. Stable Structure: In a corporation, each and every department is handled by the head of the department who are selected according to his experience and proper election method. A corporation has a corporate policy and strategy for the corporation that helps in the smooth running of the business.

Answer 2.

LLC: Importance for a Startup company:

Small startups who want to startups their business, prefer LLC as their business formation. As we have discussed the main advantages of an LLC, we can see that it is very easy to set up and not expensive. At the starting of a business, owners have limited resources and money to invest in the business.

Unlike a Corporation, an LLC has less bureaucratic requirements such as no need to hold AGM, recording minutes of meetings, having directors, periodical meetings, etc.

We can decide the members of the business and give them a percentage of shares as per their job roles and responsibilities in the business.

This can help in reducing your personal taxes if you are loosing in your business in initial years because LLC provides a pass-through tax option that means there would be no separate taxes need to file for business and owner.

These are the reasons startup founders prefer an LLC for the business in initial years of business, basically, this is one of the best business formation methods for an early-stage startup.

Corporation: Importance for a startup company:

The main advantage of a corporation is the stock structure that differentiates it from all other business structures. When you grow in the future, you need a huge capital to run the business. All financial and non-financial investors need a corporation structure for their investment. Because they want to get preferred shares of stock that are not possible with any other business formation.

The other advantage that a startup is looking in a corporation is we can give stock options to employees that are the main resource of any business. Because employees can get huge benefits from stock options in the future, employee prefers to join a corporation startup.

It is a legal and structured business structure, that needs to follow many compliance filling, failing to that, a huge penalty will be attracted to the startup. So startup that has registered as a corporation will follow all guidelines at each stage of their life, which gives a positive feel to the investors and other stakeholders.

Answer 3.

It should be kept in mind that all business structures have their own advantages and disadvantages and a business structure will not be permanent for your startup. It will change and you will be forced to be changed your business structure according to the situation and requirement of stakeholders.

When it comes to startups then most of the startups start an LLC as their business formation as it's easy to start and need less maintenance. But when we grow and need capital and other resources such as money, employees, approvals, etc we need to convert an LLC to a more structured Corporation.

This is the main responsibility of founders to think about the business formation because it may impact in the future. Founders have to think about the nature of the business, future capital requirements, future plans, expansion plans, etc. So it should be decided at the starting stage that what form business is required now and in the future. Because it can impact their business in so many ways, such as,

a. Taxes: As we have discussed the tax pattern for both LLC and corporation business structure. It can impact in tax structure in the future and can cost more to the founders in the future.

b. Stock Option: Big investors and talented & experienced employees prefer to join a corporation because they can hold company stock for future benefits, that are not available with LLC. So if we are into the business that needs more capital and talented employees in the future, it is always beneficial to form a corporation.

c. Government approval and licensing: Many kinds of business or product approvals, licenses are provided to more structured corporations only. So starting with LLC will impact our future business if we need these kinds of approvals for our business.

d. Cost and expenses: Both the form have the different cost structures and will need different expenses in the future on compliance filing, meetings, printings, legal formalities, so we need to think about these aspects that can impact our future business.