A startup's choice of corporate structure can shape its trajectory for years. Your startup's structure affects your day-to-day operations and long-term prospects, including fundraising, tax implications, operational procedures and growth potential. Given that small businesses make up 99.9% of all US businesses, this decision is a common, fundamental part of planning for growth and sustainability.

Regardless of what kind of startup you're building, you should understand the differences between a limited liability company (LLC) and a corporation. The differences largely come down to how they're taxed, how they're managed and how profit distribution works. LLCs offer more flexibility, while corporations have a formal structure and more administrative requirements.

Below, we'll discuss the key distinctions between these business structures, explain how they might affect your startup and provide guidance on how to make this important decision.

What's in this article?

• What is an LLC?
  
• What is a corporation?
  
• LLCs vs corporations: Similarities and differences
  
• How a business should choose between an LLC and a corporation
  
• How Stripe Atlas can help
  

What is an LLC?

An LLC is a specific type of business structure that combines elements of corporations and partnerships. It's a popular choice among small business owners because of its flexibility and protection benefits.

Here are a few key characteristics of an LLC:

• Limited liability: an LLC provides its owners (known as members) with limited liability. This means that the personal assets of the members are protected if the business incurs debt or is sued. Corporations offer similar protections.

• Pass-through taxation: Unlike corporations, an LLC typically doesn't pay corporate taxes. Instead, the profits and losses of the business "pass through" to the personal income of the members, who then report this information on their personal tax returns. This avoids the "double taxation" that can occur with corporations, where profits are taxed first at the corporate level and then taxed again when they're distributed as dividends.

• Operational flexibility: an LLC is more flexible than a corporation in terms of operations and governance. For example, there are fewer requirements for annual meetings and recordkeeping.

• Ownership flexibility: An LLC can have any number of members, and these members can be individuals, other LLCs, corporations or even foreign entities. Unless the LLC's operating agreement states otherwise, members can freely transfer their ownership interests in the LLC.

• Management structure: Members of an LLC can choose to manage the business themselves ("member managed") or appoint managers to handle the business operations ("manager managed").

What is a corporation?

A corporation is a type of business entity that's legally separate from its owners. It's created under the laws of the state where it's registered and considered a separate "person" for legal and tax purposes. This means it can own property, enter contracts, sue and be sued, and engage in business operations, just like a person.

Here are a few important characteristics of a corporation:

• Limited liability: Similar to an LLC, a corporation provides its owners (known as shareholders) with limited liability. This means shareholders aren't personally responsible for the corporation's debts and liabilities. Their financial liability is limited to the amounts they've invested in the corporation.

• Transferability of shares: Shares of stock represent ownership of a corporation and are typically easy to transfer. Shareholders own portions of the corporation, but a single person can own a corporation if they're the only shareholder.

• Perpetual existence: A corporation has a perpetual existence. That means it continues to exist even if its owners change or die. This is a significant advantage for long-term business planning.

• Double taxation: Unlike LLCs, corporations can be subject to double taxation. This occurs when the corporation pays corporate income tax on its earnings, and then shareholders pay personal income tax on those earnings when they're distributed as dividends. However, some small businesses can avoid this by electing to become S corporations (S corps), which are taxed similarly to LLCs.

• Management structure: Corporations have a formal structure that includes shareholders, a board of directors and officers. The shareholders elect the board of directors, which in turn oversees the corporation's overall direction and strategy. The board appoints officers (e.g. CEO, CFO) to manage day-to-day operations.

Types of corporations

Corporations come in several forms, each with its own advantages, disadvantages and specific applications. Here are the main types of corporations:

• C corporation (C corp): This is the standard corporation type. A C corp is legally separate from its owners, provides limited liability protection and has a formal management structure. Its ownership is easily transferable through shares. The major drawback of a C corp is the potential for double taxation – once at the corporate level and again at the individual level when profits are distributed as dividends to shareholders.

• S corp: An S corp is designed to avoid the double taxation issue associated with C corps. Instead of being taxed at the corporate level, the corporation's profits or losses pass through to shareholders' personal tax returns, similar to an LLC. However, S corps can have no more than 100 shareholders, all shareholders must be US citizens or residents, and they can issue only one class of stock.

• B corporation (B corp): A B corp is a for-profit corporation committed to creating public benefit in addition to generating profit. This means B corps have societal and shareholder responsibilities. B corps must meet certain standards of social and environmental performance, accountability and transparency. A third party (B Lab) handles the certification process, and a business can be both a certified B corp and a C corp or S corp.

• Non-profit corporation: Non-profit corporations are organised to fulfil a charitable, educational, scientific, religious or literary purpose. They are tax-exempt under Internal Revenue Service (IRS) section 501(c)(3), and any profits made must be used to further the organisation's mission, not distributed to members or directors. Donations made to a non-profit corporation are often tax-deductible for the donors.

• Professional corporation (PC): PCs are corporations for professionals such as doctors, lawyers, accountants and engineers. In many states, these professionals aren't allowed to form a standard corporation or LLC so they form a PC instead. Although PCs usually offer the same limited liability protection as standard corporations, professionals might still be personally liable for malpractice claims in some cases.

• Close corporation: Close corporations are more common in smaller business operations, with a more limited number of shareholders and a less rigid management structure. They often operate more like partnerships. The shares of close corporations aren't sold to the general public and often come with transferability restrictions to prevent the business from becoming publicly traded.

The appropriate choice of corporation type depends on a variety of factors, including the number of shareholders, the need for capital, tax considerations and the overall business goals.

LLCs vs corporations: Similarities and differences

The biggest similarity between LLCs and corporations is that both business entities provide owners with limited liability protection. However, they differ substantially in terms of structure, management, taxation and ownership rules.

Here are the similarities and differences.

Similarities

• Limited liability: Corporations and LLCs provide limited liability protection. This typically means the owners aren't personally responsible for business debts and liabilities.

• Separate legal entities: LLCs and corporations are separate legal entities created by state filings.

• State regulation: Both are regulated under state law and formed by filing the necessary documents with a state agency, usually the secretary of state's office.

Differences

• Ownership: Corporations determine ownership through the issuance of stock, which can be transferred easily among an unlimited number of shareholders. In contrast, LLC ownership is often harder to transfer and might require approval from other members. Some states restrict the number of members an LLC can have.

• Management: Corporations have a fixed structure that consists of officers, shareholders and a board of directors. Shareholders elect the board and vote on major corporate issues, the board oversees the corporation's business and affairs, and the officers manage day-to-day operations. LLCs have more options than corporations; they can be managed by the members (owners) or by managers, depending on the terms of the LLC's operating agreement.

• Taxation: Corporations are treated as separate tax entities and are subject to double taxation. The corporation pays income tax on profits, and shareholders pay personal tax on them again when they're distributed as dividends. In contrast, the profits and losses of LLCs generally pass through to the owners' personal tax returns. However, an LLC can choose to be taxed as a corporation, and a corporation can avoid double taxation by electing S corp status, if it meets certain requirements.

• Formality and paperwork: Corporations must adhere to more formalities and comply with regulations, such as by holding annual meetings, maintaining corporate minutes, and having a board of directors. LLCs aren't usually required to observe these formalities.

• Profit distribution: Corporations have set rules for profit distribution based on the number and type of shares owned. In contrast, LLCs have more flexibility and the members can decide how to distribute profits.

• Cost of formation: Corporations often have higher filing fees and extra annual compliance costs due to stricter regulations and formalities, while LLCs generally have lower filing fees and ongoing compliance costs.

How a business should choose between an LLC and a corporation

Choosing the right business structure can influence funding options, tax implications, operational flexibility and even the long-term success of the business. This is how a startup might decide between an LLC and a corporation:

• Founding team's future vision: Consider the type of business you're planning and your long-term goals. If you envision a less formal management structure or one that will primarily involve a few key owners, an LLC might be a good fit because of its flexibility and simplicity.

• Investment and funding needs: Corporations, specifically C corps, are often a better fit for startups that plan to seek funding from venture capitalists or through an initial public offering. The stock of a corporation is easily transferable and can be divided into different classes with different rights, which is attractive to investors.

• Tax considerations: Corporations will typically pay more taxes because LLCs aren't taxed at the corporate level, although S corps can also avoid double taxation. Because an LLC's profits pass through to the owner's personal income, this structure is best suited for solo entrepreneurs and small businesses. Larger businesses that might reinvest profits rather than distribute them can benefit from incorporation.

• Employee compensation: LLCs and corporations can both hire employees. A corporation is the best choice of structure if you plan to offer stock options as a part of employee compensation, a common practice in many startups. While LLCs can distribute membership interests, this can be a more complex process than issuing stock options in a corporation.

Fully understanding your business' unique attributes can help you choose the best business structure, increasing stability, growth and success. Approach the decision with thorough research, thoughtful deliberation and professional counsel.

It's possible to turn an LLC into a corporation if you decide to issue stock or reinvest profits in the business, but changing your business structure after you've established your company can be complicated and costly. It's worth taking the time to make the right decision from the start.

How Stripe Atlas can help

Stripe Atlas sets up your company's legal foundations so you can fundraise, open a bank account and accept payments within two business days from anywhere in the world.

Join 75K+ companies incorporated using Atlas, including startups backed by top investors like Y Combinator, a16z and General Catalyst.

Applying to Atlas

Applying to form a company with Atlas takes less than 10 minutes. You'll choose your company structure, instantly confirm whether your company name is available and add up to four co-founders. You'll also decide how to split equity, reserve a pool of equity for future investors and employees, appoint officers and then e-sign all your documents. Any co-founders will receive emails inviting them to e-sign their documents, too.

Accepting payments and banking before your EIN arrives

After forming your company, Atlas files for your EIN. Founders with a US Social Security number, address and mobile phone number are eligible for IRS expedited processing, while others will receive standard processing, which can take a little longer. Additionally, Atlas enables pre-EIN payments and banking, so you can start accepting payments and making transactions before your EIN arrives.

Cashless founder stock purchase

Founders can purchase initial shares using their intellectual property (e.g. copyrights or patents) instead of cash, with proof of purchase stored in your Atlas Dashboard. Your IP must be valued at US$100 or less to use this feature; if you own IP above that value, consult a lawyer before proceeding.

Automatic 83(b) tax election filing

Founders can file an 83(b) tax election to reduce personal Income taxes. Atlas will file it for you – whether you are a US or non-US founder – with USPS Certified Mail and tracking. You'll receive a signed 83(b) election and proof of filing directly in your Stripe Dashboard.

World-class company legal documents

Atlas provides all the legal documents you need to start running your company. Atlas C corp documents are built in collaboration with Cooley, one of the world's leading venture capital law firms. These documents are designed to help you fundraise immediately and ensure your company is legally protected, covering aspects like ownership structure, equity distribution and tax compliance.

A free year of Stripe Payments, plus $50K in partner credits and discounts

Atlas collaborates with top-tier partners to give founders exclusive discounts and credits. These include discounts on essential tools for engineering, tax, finance, compliance and operations from industry leaders like AWS, Carta and Perplexity. We also provide you with your required Delaware registered agent for free in your first year. Plus, as an Atlas user, you'll access additional Stripe benefits, including up to a year of free payment processing for up to $100K in payments volume.

Learn more about how Atlas can help you set up your new business quickly and easily and get started today.