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Startup Company Form: LLC or S-Corp? Which is easier and which is better?
22 points by sabat on April 17, 2007 | hide | past | favorite | 31 comments

Ordinarily a startup should be a C corp. It's cheaper to be an LLC, but if you plan to succeed, you may as well do things right from the start.

With an LLC profits don't get taxed twice like in a regular corporation. So it makes sense to be an LLC if you expect to have substantial profits, but don't expect to grant options, sell shares, or get bought. Consulting firms and law partnerships are often LLCs. YC is an LLC.

The big reason why C corps are preferable is because S corporation shareholders can only be people -- not other businesses, like VC firms. (S corps also can't issue preferred stock.) An S corporation can't take venture capital without first reverting back to C corp status. But an S corporation can save a lot of money on taxes.

But although many of our businesses want venture capital, most are unlikely to get it. In fact, I'd hazard a guess that more tech startups will have income than will have external corporate funders. (This usually happens when the founders need some money, so they put their original idea on hold and do some consulting for a while. Eventually they're doing exclusively consulting, because it pays well, or at least it pays off quickly.) By that point, you're probably unlikely to remember the tax consequences and switch to an S corp.

Why not start out as an S corp, and switch to a C corp iff you acquire VC or sell preferred stock?

The startups we've seeded are more likely to get funding than to consult on the side. When they do consult on the side they do it as individuals, not as the company.

You're right - an LLC is not taxed like a regular corporation. However, neither is an S-Corp.

If I remember correctly from my corporate tax class, both LLCs and S-corporations are generally treated as "pass through entities" (if the appropriate elections are made). Therefore S-Corporations are not subject to double taxation.

Edit - here's more info: http://www.nolo.com/article.cfm/objectID/A30CE890-BBAA-4B8A-AD66A33FA038988B/111/182/241/ART/

Another interesting note: In some cases LLCs can be taxed as corporations (and therefore subject to double taxation), if the founders don't file the appropriate form.

Just to be safe, if you're forming an LLC, you want to file form 8832 and elect to be classified as a partnership (if there's more than one partner), or "disregarded as a separate entity" (if you're all alone). DO NOT elect to be treated as a corporation - unless you want to be taxed as such.

Check-the-box regulations:

- http://www.llcweb.com/struc.htm

- http://www.irs.gov/irm/part4/ch47s05.html#d0e501936

- Form 8832: http://www.irs.gov/pub/irs-pdf/f8832.pdf

Our actual product is different than our original idea when we formed the LLC although it uses technology from the original. What do you think of the idea of forming a C corp for the new application that is then owned initially by the LLC? (Our idea is to have core technology provided by the original LLC to a series of applications)

These multi-company organizations are almost always a bad plan. And even if they weren't, all investors think they are, so this sort of thing is a big red flag.

Let's say you have developed your own programming language/infrastructure, such as Arc or GOAL or whatever. You want to use your tools for a new venture because they give you a lever your competition doesn't have. On the other hand, if the venture doesn't work out, you don't want your language/tools to be part of the liquidation, so you are not deprived of them in the future.

This is impolitic, but if you were starting a new venture and Arc were ready to be used in production, would you want to put it into the new company and, if not, how would you handle investors? This is a little more than hypothetical since you are using Arc in Ycombinator business, but it seems like a different situation than when forming a company with investors you barely know.

I would make the language separate from the company, drawing the line perhaps at libraries specific to the company's project.

Thanks, that is good to know. So if we create a new C corp with our new application and build in an API, then create an add-on service with our original LLC later that can add value to the new application, the investors would be less worried?

If you're creating a corporation, why not just disband the LLC? Why keep two company structures?

The issue is that we have a code base for the first company (Coding started about 6 years ago) that we want to develop into a different and much bigger product. The problem is much harder than our current startup, and we wanted to use the startup to help finance the bigger problem. We want to leave open the option of selling the startup and don't want to risk having to give up the legacy code and ideas which we think could be a dramatically bigger company. (The first company owns all that code). Once we develop the first ideas under the LLC further, we would have to convert it into a C Corp before going for investment. In the meantime, the LLC can own that code at low expense.

Well, you know more about your situtation than I do, so I'm not going to second-guess your strategy. But this does sound a little complex -- too complex for YC News to be much help. A $200 consultation with a lawyer might prevent a big headache later.

Good point - can anyone recommend a good lawyer who is not outrageously expensive?

VCs want to invest into a C-corp because it allows them to have a flexible share structure so if you're seeking VC money, C-corp will be a must. But, in the mean time, you CAN use S-corp since it is easy to set up and gives you some protections. S-corp can be easily converted into a C-corp (a single supplemental form!). LLC is not as easy to convert to a C-corp and paperwork is fairly complex and will cost you several K.

Thing to note about S-corps is that all founders _MUST_ be American citizens.

From the article: "My personal practice has been to create an LLC (they are simple, avoid double taxation and still support multiple classes of stock if needed). If and when the time comes to convert the LLC to a C-corp, the process is not that difficult. Whatever costs you would incur in the conversion process, I think are offset by the upside you get during the time that you can benefit from being an LLC. An LLC can be setup for a few hundred dollars and likely meets the needs of most early-stage entrepreneurs."

startupping.com has had some chatter about this in its forums as well. That site tends to have some good practical discussions like this, and other things as well. It's a nice complement to this one.

To me the answer is simple: If you are looking to be VC or angel funded yet are just starting out then you should save the money and start an LLC. If you don't plan on VC funding then stick w/ an S Corp.

In 1999 we had an LLC and we converted it to a C Corp just before we acquired funding in 2000. This time around I'm a partner in an S Corp and am self-funding it. If my current situation changes, as someone already mentioned, it will be easy to change over to a C Corp.

What exactly is the reporting/paperwork required for a C-corp (which people mention as more overhead than LLC)?

I don't see it as a big deal but C corps require Board of Director meetings, Shareholder meetings, corporate minutes and corporate resolutions. From what I read, LLCs don't require these things but you may want to do them if your LLC involves more than a few people.

LLC taxes probably aren't much different than corporate taxes. Calculating profit is the hard part and you have to do that in both cases.

Creating an LLC is often just a little bit of paperwork, just like a corporation. It may vary, depending on your state. Since you only do it one time, anyway, the burden in terms of creation paperwork isn't usually significant.

Oh, and I suppose that the issuing of corporate stock might be considered more complex than creating interests in an LLC. Technically, it is probably not more physical paperwork or actual reporting but the knowledge and burden is probably significantly greater.

if you take money from investors they will require you to be a C-Corp. If this path is in your plans, it is probably easiest to start off this way.

I went for a Delaware C-Corp. Costed me $300 to incorporate + 30 in annual fees, so far for the first year. This was a relatively large expense for me so let's hope it was worth it.

You should be able to get your annual fees down below $300 - it should only be about 1/2 that

edit: you are correct.

Maybe I'm wrong, but I read the page above differently from you. The $200 fee applies to LLCs, Limited Partnerships or General Partnerships.

You're a C-Class Corp right? Therefore you pay the corporate franchise tax. If you go to the link on the page entitled "Franchise Taxes Here": http://corp.delaware.gov/frtaxcalc.shtml

it tells you what it should be. Your fee will vary depending upon how many shares you have outstanding, but I'm guessing you have less than 3,000 therefore it will be $35.

An LLC has less overhead, from what I understand, but maybe there are buyout/VC implications? What do most startups do these days?

We went for a California LLC after doing a few weeks of research. It is the easiest structure we could find with the least expense. We don't know what the future funding implications are for it though.

I heard that a LLC can be converted to a Corp when you get funded. I'm not a lawyer, so I'm not 100% sure about it.

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