When starting a business, choosing the correct form of business entity best suited for your company will be advantageous in the long run. There are two common business entities to consider, a corporation and a limited liability company.
Corporations are the traditional form of business entity that is normally used by larger companies. A corporation is legally recognized as an independent entity, separate from the owners. A corporation would require strict management and recordkeeping procedures. A corporation will protect shareholders from liability issues.
The owners of a corporation are referred to as shareholders. The corporation issues shares and the number of shares the shareholder has would correspond to the percentage of ownership. Corporation shares are easily transferable from shareholders. A corporation has perpetual life, meaning that a death of a shareholder would not interfere with the existence of the company. A corporation management structure is very strict. There must be a board of directors who oversee the Entire Corporation, and officers that run the company. They must hold an annual shareholder meeting and make annual reports.
Members of a corporation are protected under the business, which is also known as the corporate veil. It protects the shareholders from personal liability for business debts and claims. If the company cannot pay off a creditor, the creditor cannot go after the assets of a member of the company. This is desirable because if one shareholder makes a mistake, not all shareholders must pay the price.
One reason a corporation is not preferable is the tax structure. The profits of a corporation are taxed when they are earned. Later when the profits are distributed to shareholders, it will be taxed again.
Limited Liability Companies
The owners in a limited liability company (LLC) are referred to as members. Each member owns a specific percentage of the business. Transfer of ownership in an LLC is not as easy in a corporation. It is required that all members of the LLC agree on the transfer. Depending on the state, a LLC may have to be dissolved if a member is no longer able to be part of the company. LLCs function more as a business partnership than a corporation. Members of a LLC do not need to have formal business titles, or be run by a board. Establishing a LLC will essentially allow a company to have the flexibility of a partnership while having the protections from liability and debt that a corporation entity would provide.
Similar to a corporation, the members of a LLC are also protected by the corporate veil. Only in extreme cases – such as fraud within the company – can a member of a LLC be held personally liable for his actions in the business.
A LLC is similar corporation, however it has more flexibility in management. Taxation in a LLC is also more lenient, and the entity in its own has less recordkeeping procedures. The tax structure of an LLC is also preferable to that of a corporation. The income that the business earns is transferred to the members of the LLC who then report their share of profits on their individual income tax returns, and pay taxes accordingly.
Deciding which entity would be right for you would depend on the scope of your business. A corporation would be more preferable for larger companies that require more formation and structure. It would also be more viable if the company needed investors or if the company would like to provide shares for employees. However, if you own a small business, a LLC may be a better option, as it will be easier to choose reliable business partners.