Considerations in Forming a LLC or Corporation

Most of the people that come to After Incorporation already have formed the entity in which they carry on their business. They take advantage of the resources at After Incorporation to keep their company organized and in compliance with ongoing legal requirements. The information in this section is intended to help people who have not yet formed the entity in which they will conduct their business. It is meant to help you think through what type of entity you should form, and where you should form it, before you run off and submit something to the state.

The reason people generally form an LLC or Corporation to conduct their business is to insulate their personal financial situation from the risks associated with conducting the business. As we like to say, Limited Liability is a Good Thing. So, if you have decided to take advantage of setting up a separate legal entity through which to conduct the business, which one is right for you? The answer to that question is based on the particulars of your situation. Some situations have an easy answer. Others are more complex.

A starting point is to define some terms and understand a few differences between the types of entities. Both a LLC and a Corporation, if properly maintained, generally protect the investor from liabilities associated with the business. There are two types of LLCs, identified by how they are managed. A member-managed LLC is similar to a partnership where all the members are partners. A manager-managed LLC is structured more like a corporation in terms of tiered management structure.

An LLC is taxed on a pass through basis to the investor with the tax paid by the investor. A corporation has a choice to either elect to be an "S" corporation and taxed in the same way, or if it does not so elect will be treated as a "C" corporation. A "C" corporation is treated for tax purposes as a separate taxable entity which is taxed and its remittances to shareholder, or dividends, are taxed a second time.

A second distinction between LLC's and corporations is there is generally a lower standard of record-keeping required for maintaining a LLC. However, if there are multiple investors in the LLC there are many "information retention" requirements that under those circumstances make the differences in requirements somewhat illusory.

Another consideration that often drives where to set up your corporation or LLC is the requirement and cost associated with having a registered agent. When you set up an LLC or corporation you are required to nominate someone to receive things like service of process and notices from the state. If you set up the LLC or Corporation in the state in which you reside, you can name yourself as the registered agent and save the expense. It also makes sense to do that because if you need any legal advice you can get it locally and the advisor will be familiar with the law and not need to learn on your dime, so to speak.

The more traditional entity for big business and companies with large numbers of shareholders and investors in a Corporation. The traditional entity for a single owner entity with only debt financing is a member-managed LLC.

So now that all the issues are on the table, what form is right for you?

If you are technology company that anticipates getting venture money, many outside investors and multiple rounds of multi-million dollar investments, set up a Delaware corporation. It will be somewhat more expensive but the nature of your business is such that it makes sense to go that way. A site set up by a large law firm that caters to those types of companies, Goodwin Proctor, has links that provides forms for such an entity. It is found here.

If you are a services company with one owner and only debt financing, set up a member-managed LLC in the state in which you operate your business.

Unless there is some imperative otherwise (like the preference for multiple large investors for a Delaware corporation), set up the entity in the state in which you reside and do your business. It will likely save you money in both the short and long run.

If you anticipate 1-3 investors, consider the LLC. Chose the form based on the management style that the business will employ and have the formation documents reflect that choice.

If you anticipate more than 10 investors, consider the corporation. You can choose to have the profits taxed directly by electing subchapter "S" treatment. Most business startups do not need to worry early on about profits anyways.

If you expect your business to be in the area of 4-10 investors you need to make a judgement with tradeoffs, but at least now you know what the tradeoffs are all about.

In order to form your business entity, go to the state you will be forming your entity in, found in the Free Formation Resources section. All of the forms required to set up your entity in that state are provided at no cost to you with a link to the appropriate state entity and forms.

Once you have filed your formation document with the state and created your secondary formation documents you are ready to use all of the resources at After Incorporation to keep your company organized and in compliance with ongoing legal requirements.