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Learn the types of business structure common among tech startups.

Think your startup’s business structure isn’t that big of a deal? When you’re one or two founders with a credit card bootstrapping your way to determining if your business idea has what it takes to succeed, maybe that’s true. But what if you have employees – with or without equity? Money from friends and family? Now, it gets a little more complicated.

Forward-thinking entrepreneurs need to consider their tech startup’s goals and understand it’s impossible to predict the future. If growth is your goal, consider your structure carefully. Does an LLC or a C Corp give you more of what you need? Your choice of business structure may help or hurt you down the road.

Startup Business Structure Defined

As we explore the types of structure best suited for startups, let’s define what we are talking about. Business structure is defined as “a category of organization that is legally recognized in a given jurisdiction and characterized by the legal definition of that particular category.” You may see this referenced also as business organizational structure, though the terms are not one and the same. Business organizational structure for a startup refers more directly to reporting relationships within a company, something your tech startup business structure will affect.

You likely will structure your startup, or business entity, in one of two ways:

  1. LLC – a limited liability company (LLC) is considered a simple way to structure a startup, one that offers some tax benefits and personal asset protection to founders.
  2. Corporation – a legal business entity comprised of a group which acts as one company, which allows a startup to operate their business with the same rights as an individual.

Founded a startup before? You’ve likely been through these terms. But every startup is a little different, and the recommended way you structure your business entity is determined by the goals and differentiators of your company.

Pros and Cons of LLCs and Corporations for Startups

Nearly every startup we speak with has long-term scalability in mind even before they launch. The business structure of your startup does affect the way in which you grow, so the classification of your business needs to be an early concern (especially if you’re a tech startup). Here’s a run down of the pros and cons for the two major types of startup business structure (including s-corp and c-corp considerations):

LLC

A limited liability company (LLC) has certain freedoms that a corporation doesn’t enjoy, such as exclusion from certain business functions like annual stock meetings, establishing a board of directors, and other corporation-specific compliance areas. Since they are easier to establish, it isn’t uncommon for a startup to start out as an LLC. However, many venture capitalists prefer only to work with startups that are structured as corporations.

Here are some pros and cons of structuring your startup as an LLC:

    • Individual taxation of company profits.
    • Can operate as a “pass-through” company.
    • Founders can’t be employees.
    • Investor members have more rights.
    • Stock cannot be issued, limiting a startup’s ability to offer employees equity (giving out stakes in your company is a great way to recruit and retain top-tier talent).
    • Investors may prefer or require corporation classification.

Corporation

If you’re intent on structuring your startup for long-term growth, then incorporating your business entity is a smart move according to Forbes. Startups should consider the type of corporation that is best for them – choosing between a c-corp or s-corp. Deciding on the best corporate structure for a startup should not be taken lightly, as the decision to classify as a c-corp or s-corp will affect tax amounts,  fundraising ability, and how easy it is to scale your business.

Here are some pros and cons of structuring your startup as a c or s corporation:

    • C-Corp: A c-corp is the default (or general) corporation type, meaning that if no specification is given when you file letters of incorporation, your startup will be classified as a c corp.
      • Company responsible for taxes.
      • Flexible equity/stock options.
      • Better for you regarding shareholder rights – allows for more robust cap table.
      • Recent tax laws benefit c corporations.
      • Double taxation.
      • Regulations that apply to your business operations.
    • S-Corp: An s-corp is a corporation with a special tax status. Whereas income from a c-corp is taxed twice, it is only taxed once in an s-corp.
      • Not as common but may have some advantages over C Corp depending on the situation.
      • Can, along with an LLC, operate as a pass-through company.
      • Income is taxed once, but profits and losses are shared with stockholders of an s-corp.

Which One is Best for Your Startup?

Deciding on how to classify your business entity is tricky. It seems like everyone has an opinion. Certainly the financial impacts of business structure take the forefront for many startup founders, as do liability and corporation compliance.

What seems to work the best for every startup founder we encounter is building a solid strategy: a plan that will take into account the pros and cons listed above and guide you as you found your startup.

Need Expert Advice?

Deciding on the business structure of your startup is a key decision, one that’s best made by consulting several professionals – lawyers, financial planners, and startup growth specialists like ourselves. The long-term implications of your business structure are not irreversible. If your startup’s structure isn’t what will equip you to grow into the future, it’s not too late to change.

Michael Cerino is the CEO of Growthwright. Growthwright helps emerging technology companies with necessary business operations so they can focus on company growth without the distractions of critical financial, technical, human resource, sales and marketing tasks