Should I Form an LLC or a Corporation?

If you’re just starting on your entrepreneurial journey, a LLC (limited liability company) is almost certainly the way to go.

Unlike a corporation, a LLC is considered fully organized from an entity standpoint as soon as the relevant jurisdiction issues a letter (attached to the filed Certificate of Formation) stating that the entity has been formed on a certain date.

To understand the steps needed for a corporation to be fully organized, check out this article.

Corporate Formalities

In addition to the steps needed to be fully organized, a corporation has many corporate formalities that must be observed.

For example, acts by directors and shareholders need to be at a formal meeting where minutes are recorded or via written consent.

If these formalities aren’t observed, this may give rise to allegations that the directors or shareholders acted without authority; this may lead to lawsuits down the line.

As well, if corporate formalities aren’t observed, this may lead a judge to “pierce the veil,” thereby subjecting the shareholders of the corporation to personal liability for the corporation’s obligations.

Does an LLC Need an Operating Agreement?

Most states do not require that an LLC have an operating agreement.

California, New York, and Delaware, Maine and Missouri are in the minority of states that do require their LLCs to have operating agreements.

Irrespective of whether an operating agreement is legally required, it is highly recommended that an operating agreement be adopted, as this would increase the probability that all the members are on the same page with respects to their rights and responsibilities.

Furthermore, in the absence of an operating agreement, the default rules under the jurisdiction’s limited liability company laws would apply, which may lead to unintended or undesired consequences.

What if the Company will Eventually IPO?

The structure of a corporation is better suited to be a public company, but a LLC can always be converted to a corporation when and if that becomes necessary.

As long as the operating agreement is properly drafted and records of LLC ownership are properly maintained, converting an LLC to a corporation would be a relatively straightforward process.

While the limited liability company laws generally do not require that Managers or Members of LLCs act by formal meeting or written consent, this would still be good practice for documentation purposes.

Tax Considerations

LLCs enjoy pass through taxation, which means that the profits of the LLC are taxed directly at the membership level.

On the other hand, corporations are taxed both at the entity level and the shareholder level, which results in the shareholders keeping less of the profits.

Flexibility of Operating Agreements

Another reason to choose an LLC over a corporation is that the operating agreement for an LLC can be much more tailor made than the bylaws of a corporation.

Generally speaking, almost all of the default rules of limited liability company law can be overridden by the operating agreement.

By contrast, while some provisions of the corporate law can be overridden by the bylaws, many provisions of the corporate law cannot be changed.

To better understand the laws that govern corporations, check out this article.

Conclusion

Early stage companies should strongly consider organizing as a limited liability company instead of a corporation.

In addition to simplicity for governance purposes, there are also tax benefits.

Because LLCs can be converted to a corporation at a later stage, there is minimal downside with starting with a LLC as proper planning and documentation is in place.

Disclaimer

This is not legal advice and does not create an attorney-client relationship between you and the author. This article is being furnished for educational purposes only.

The author makes no warranty as to the accuracy, completeness or applicability of the information and undertakes no obligation to update the information.