Learn about different entity types to decide what type of entity you should form.
When setting up your entity, one of the key initial decisions you must make is entity type. Various factors inform the decision, such as but not limited to; liability and risk allocation, tax implications, and governance infrastructure. There are three main types of entities: C-Corps, S-Corps, and Limited Liability Companies (LLCs).
C-Corps
Stockholders hold equity in C-Corps, and that equity is distributed amongst the stockholders by issuing preferred or common stock, making C-Corp organizations particularly attractive for investors. Liability is also limited in a C-Corp, meaning that individual stockholders cannot be held personally liable for the debts incurred by the company. Stockholders however, only vote on major decisions, as corporate governance is conducted mainly by a Board of Directors.
One important consideration however, is that C-Corps are NOT flow-through tax entities, so they suffer the disadvantage of double taxation. This means that they are taxed at the corporate level, and stockholders pay dividend tax in addition to that initial entity taxation.
Limited Liability Companies (LLCs)
A Limited Liability Company (LLC) is typically easier and cheaper to run than a corporation. They are composed of members whose liability is limited, much like a C-Corp. But unlike a C-Corp, LLCs are flow-through tax entities, meaning that the company does not pay taxes at the entity level. Rather, the only taxation occurring is the income tax paid by shareholders based on their equity, thus mitigating the double taxation pitfall. Equity is allocated by membership interest, determined either by ownership percentage or units.
Furthermore, LLCs are governed by the means set out in its Operating Agreement. As a result, there is tremendous flexibility as to the governance of LLCs, although members commonly appoint managers to govern the company's day to day functions.
S-Corps
C-Corps and LLCs may elect to be taxed as an S-Corp provided that they comply with Subchapter S guidelines. A small company may elect to be taxed as an S-Corp if the following conditions are met:
1. the company has no more than 100 shareholders,
2. no shareholder is not an individual,
3. no shareholder is a nonresident alien, and
4. the company issues no more than one class of stock.
Moreover, the company should not have previously elected S-Corp status and terminated such tax status within the last five years.
Much like a C-Corp, S-Corps are owned by stockholders. Equity is granted by issuing stock; however, only common stock may be issued because of the limit to one class of stock rule. Also, similar to LLCs, S-Corps are flow-through tax entities, and only its dividends are taxed at the stockholder level. In this way, S-Corps reap both the benefit of being able to issue stock enjoyed by C-Corps and the benefit of not being subject to a double tax enjoyed by LLCs. S-Corps are also governed by a Board of Directors with stockholders only voting in major decisions.
Conclusion
In conclusion, C-Corps, LLCs, and S-Corps all reap the benefits of being limited liability entities. However, for companies seeking to raise investors, it is important to consider that investors tend to prefer C-Corps. On the other hand, LLCs require less corporate formality and have a more favorable tax status, and this flexibility may provide more convenience for corporate governance. Finally, S-Corps may be thought of as a hybrid between C-Corps and LLCs, reaping the benefits of both formations, albeit subject to the limitations outlined in Subchapter S.
| C-Corps | S-Corps | LLCs | |
| Ownership | Stockholders (can be a single individual) | Stockholders (no more than 100) | Members |
| Owner Liability | Limited | Limited | Limited |
| Equity Distribution | Common Stock OR Preferred Stock |
Common Stock (sub-series common stock with different voting rights permitted) |
Membership Interest (by percentage ownership or units) |
| Flow Through Tax Structure | No | Yes | Yes |
| Public Offerings | Yes | Yes | No (if taken public, LLC will be taxed as a corporation) |
|
Management/ Governance |
Board of Directors | Board of Directors | Managers (flexible) |
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