Starting a business can be an exciting yet daunting process. One of the most critical decisions you’ll face early on is choosing the right legal structure for your startup. At Build Accounting, we often recommend that startups begin as a Limited Liability Company (LLC). While there are many potential structures to choose from, such as a C Corporation or an S Corporation, LLCs offer a unique blend of flexibility, simplicity, low cost, and protection, making them an ideal starting point for many new businesses. Let’s explore the reasons why we recommend a startup’s first legal structure being an LLC.
1. Flexibility in Taxation Options
One of the biggest advantages of forming an LLC is the flexibility it offers when it comes to taxes. As an LLC, you have the option to be taxed as a sole proprietorship (for single-member LLCs), partnership (for multi-member LLCs), or you can later elect to be taxed as an S Corporation or a C Corporation. It’s easy for your startup to begin as an LLC and change down the road when your business evolves.
- Pass-through taxation: By default, an LLC enjoys pass-through taxation, meaning that the profits and losses of the business are reported on the owners’ individual tax returns, avoiding double taxation at both the corporate and individual levels, which is common with C Corporations. Also, when a startup first begins it’s common to lose money. These losses will offset the owner’s other sources of income which is beneficial to the founder.
- Elect S Corp status later: As your business grows, you can elect to be taxed as an S Corporation to potentially reduce your self-employment taxes. This flexibility allows you to optimize your tax strategy as your business evolves, without needing to change your legal structure.
2. Limited Liability Protection
Like a corporation, an LLC provides limited liability protection, meaning that the personal assets of the business owners (also called members) are generally protected from the liabilities of the business. If the business incurs debt or is sued, your personal assets (home, savings, etc.) are typically shielded.
This protection is crucial for startups that may be experimenting with new ideas, products, or services. Without this legal barrier, your personal assets would be at risk in the event of business failure or lawsuits, making LLCs a safer option for new entrepreneurs.
3. Simplicity in Setup and Maintenance
Compared to corporations, LLCs are relatively simple and inexpensive to set up and maintain. While every state has its own specific requirements, generally speaking, forming an LLC involves filing Articles of Organization and paying a filing fee, which is typically lower than the costs associated with forming a corporation.
LLCs also have fewer ongoing requirements:
- No formal board meetings: Unlike corporations, LLCs are not required to hold regular board or shareholder meetings, which makes operating the business much simpler for the owner or owners.
- Less paperwork: There’s generally less paperwork required for an LLC than for a corporation. Corporations must file annual reports, maintain corporate minutes, and keep extensive records. LLCs, on the other hand, have more relaxed administrative requirements.
4. Attractive to Investors Down the Road
While LLCs are often seen as an initial structure for businesses, they are also flexible enough to allow for growth and scalability. As your startup begins to attract investors or venture capital, it’s easy to convert an LLC into a C Corporation, which is often more attractive to larger investors. This pathway allows a business to start simply and evolve over time, reducing the initial legal and financial burdens of forming a corporation too early.
Additionally, LLC members can still raise funds from private investors, and many startups choose to remain LLCs during the early stages until they are ready for a larger capital raise.
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5. Control and Management Flexibility
Another appealing aspect of LLCs is the management structure flexibility they offer. LLCs can be managed by the members themselves (member-managed) or by appointed managers (manager-managed), providing you with more control over how the business operates. In contrast, corporations typically have more rigid management structures, with directors, officers, and shareholders all having defined roles.
This management flexibility is perfect for startups, where founders may prefer to remain hands-on with all aspects of the business in its early stages. As the business grows, there’s the option to appoint managers or professional management teams without changing the legal structure.
6. Cost-Effective Legal Structure for a Startup as an LLC
Forming a C Corporation or even an S Corporation can be more expensive due to the initial filing fees, legal setup costs, additional tax return filings, and the requirement to follow more complex rules and regulations. Starting with an LLC helps to reduce initial costs, which is particularly important for startups working with limited capital.
For example, startups can avoid the double taxation of C Corporations and bypass the strict qualification rules required for S Corporations by remaining an LLC. You can always change your structure later when your financial situation improves or when your business reaches a new level of complexity that justifies a more formal corporate structure.
Conclusion
Starting a business involves many strategic decisions, and choosing the right legal structure is one of the most important. At Build Accounting, we recommend that a startup initially forms as an LLC first because of the flexibility, simplicity, and protection it offers. As your business grows, you’ll have the option to convert to a different structure, such as a C Corporation, if that becomes more advantageous. Investors may require it as well.
In the early stages, however, keeping your structure simple and adaptable allows you to focus on what really matters: building and scaling your business.
Feel free to reach out if you’re considering forming an LLC or are unsure which structure is best for your startup!
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About the Author
Brett Rosenstein
Founder of Build Accounting
Certified Public Accountant
Brett is the founder and president of Build Accounting where he provides accounting, tax filing, and CFO services for tech startups and SaaS businesses. His goal is to make the accounting and tax process as simple, streamlined, and headache-free for business founders as possible.
Brett received a Bachelor of Science in Business Administration from The Ohio State University. He is also a Certified Public Accountant.
When Brett is not working, he is running, biking, spending time with his wife and daughter, or trying new pizza places.
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