C corp vs. LLC: Big business, big differences
Business owners face a number of decisions, both in the planning phase and the operative phase of their business. One of the major decisions every business owner has to make is how to organize and structure their business. This issue is especially important for startups experiencing growth, as growth generally means more employees, investors, stakeholders, and so on. Eventually, you could be faced with a major structural decision: C corp vs. LLC.
Understanding the similarities and differences between C corps and LLCs is essential to deciding how to register your business. Read on to learn how these two business structures are similar, how they're different, and which one might be the right choice for your business.
Breaking down C corps and LLCs
On the surface, a C corp and LLC likely look similar. Both impact the corporate tax and income tax you may pay, and both give your business a more professional appearance with vendors and investors.
But, a deeper dive reveals that these two structures also greatly affect the way you run your business. And choosing one structure over the other can have significant financial implications that don't end with taxes.
But, it's not as simple as choosing one over the other. There will be pros and cons either way. Let's take a look at C corps, then we'll examine LLCs.
What is a C corp?
A C corporation is an entity type that's owned by shareholders who purchase shares of stock. Unlike an S corp, which is a pass-through entity that is taxed on shareholders' personal returns rather than on a business return, a C corp is prone to double taxation — both the profits of a C corp business and any shareholder gains made on the distribution of dividends can be taxed.
For example, let’s say your corporate profits are taxed at a corporate level. Then, the shareholders receive their cut of the company profits. At this point, the shareholders would then be taxed for their personal income — in this case, the profits from your company — on their personal tax returns.
Because a C corp is technically owned by shareholders, a board of directors needs to act as the decision-makers for the company. The board will also establish bylaws, which dictate how the business operates. This is radically different from a sole proprietorship, in which the person and the company are one and the same.
In the case of a C corp, the shareholders may have little involvement in the company itself. (Or a lot, depending on the company and the shareholders, but this involvement isn't a given like a sole proprietorship.)
In short, C corporations are strictly regulated and have a rigid structure: shareholders and a board of directors. This makes them rather easy for investors to understand, which is a positive. When investors are looking for companies to invest in, they want safe bets. LLC structures can vary, which means they take longer to comprehend and could be less appealing to investors as a result.
As C corps are more heavily regulated, those interested in selling a company or securing investors typically choose a C corp structure. Like an LLC or S corporation, a C corp provides a certain amount of legal protection to business owners and investors, as the owners are treated as separate entities from the business itself.
What is an LLC?
An LLC, or limited liability company, is a business entity formed through articles of organization. An LLC, much like a C corp, treats the owners of a company and the company itself as separate entities. This means the owners aren't always financially and legally liable for company debts, but legal protection can vary depending on state laws. This limit of personal liability protects personal assets and ensures business owners don't necessarily go down with their company.
Beyond liability protection, an LLC gives companies a way to structure their business as they see fit. Unlike a C corp, an LLC is still owned and operated by those who found the business. A board of directors can be chosen, like in a C corp, or not. There can even be single-member LLCs, which are essentially sole proprietorships with the added protection of an LLC.
Because LLC structures can vary, they aren't the best choices for those seeking investors or angel investors. Their structure requires more research on the investor's part. All C corps, on the other hand, are generally operated the same way: A board of directors makes major decisions based on input from shareholders.
C corp vs. LLC: 5 key differences
On the surface level, a C corp and an LLC likely look similar. Both involve acquiring legal protections, assigning decision-makers, and changing how the IRS views you as a taxable, legal entity. But, the differences are huge, especially where your business goals and taxes are concerned. Here are five major differences between the two structures.
1. C corps can reorganize free of charge
Tax reorganizations can be useful for U.S. businesses and U.S. citizens looking to restructure a company for acquisition or investment. But, oftentimes these tax reorganizations can be costly. For C corps, tax-free reorganizations are possible and common, thanks to IRC Section 368. This allows your business to be sold free of taxation in exchange for stocks. For LLCs, this isn’t possible.
Because a tax reorganization is especially useful for businesses looking to avoid expensive tax costs during a business sale, C corps are a strong entity type to consider for anyone forming a business with the intention of selling it.
2. C corps have no cap on stockholders
LLCs don't allow for stockholders because of the way they're structured. A C corp can not only have stockholders, it can have unlimited stockholders. This can potentially make acquiring venture capital or finding startup investors easier for C corps than for LLCs.
The downside is that more stockholders often means more shareholder meetings with the board of directors. When left unchecked, this could lead to a company no longer feeling like your company. Without proper restrictions put in place, it’s even possible for you to lose control of your company. This is why it’s important to ensure you have classes of shares, creating clear boundaries between shareholders and your company.
3. Limited liability companies offer truly shared ownership
Along with limited liability protection, an LLC offers truly shared ownership. While you can choose to operate a single-member LLC, you can also split the company evenly between multiple people, like in a partnership. This means the profits can be shared equally, which is virtually impossible when you run a C corp and have stocks involved.
4. LLCs can have custom management structures
C corps are generally rigid in structure: a board of directors manages the company and makes decisions while shareholders have some say. An LLC can have a much more custom structure. For example, you may have multiple LLC members, each with a different role, or each part of a shared general partnership, splitting the business profits, business debts, and responsibilities.
Again, the downside to an LLC’s custom structure is that investors may be less inclined to invest. Your custom management structure can entail more homework on the investor's part to understand how your company operates and who is in charge of what. In many cases, a C corp is an easier "yes" for an investor because they know exactly what to expect as far as management goes.
5. C corps are recognized around the world
LLCs have an uphill battle when it comes to global operations and legal protections. Both C corp and S corp status are globally recognized, meaning your business can more easily operate around the world with legal protections. For many small business owners, this isn't a deal-breaker. But, if you're looking to grow your business beyond the United States, a C corp may be a better long-term choice.
LLC vs. corporation: Your business, your choice
When it comes down to LLC vs. corporation, both business types have a lot to offer. As far as taxes are concerned, neither choice is a clear winner over the other. Both offer legal protections for members, both allow the splitting of business income, and both can help your company grow in various ways.
Ultimately, the decision is yours to make. Carefully consider the pros and cons of each business entity, and more importantly, think about your business goals.
When in doubt, consult a financial advisor to discuss how either choice could impact your federal income tax, potential business growth, and beyond. With proper research and consideration, you'll arrive at a decision that helps your business grow into the empire you dreamed of when starting it.