What’s the difference between LLCs and C corporations?
Limited liability companies (LLCs) and C corporations are the two primary corporate entities in the United States. Each entity type has some features that are more advantageous for some businesses than for others.
We’ve collected some information here so that you can make an informed choice, in consultation with your professional advisors.
Orrick, the global tech law firm, is the legal partner for Stripe Atlas. Experts at Orrick contributed their expertise to this guide, and Atlas users can access a more detailed Atlas legal guide written by Orrick.
What are LLCs?
A limited liability company, also known as an LLC, is a type of company organized under an operating agreement, which is a contract between the owners (called “members”) specifying how it will be run and how the economic burdens and returns will be split between the partners.
The possibilities for how to structure an LLC are almost endless, which can be a blessing and a curse. This makes interfacing with an LLC challenging, because one has to examine the operating agreement (and potentially other contracts signed between the members) to get a handle on how the company is governed. C corporations, by comparison, are more standardized: They share commonalities like stock to represent ownership, are governance by a board of directors, have day-to-day operations handled by officers, etc.
There are a few characteristics that are common to LLCs:
- LLCs act as a business entity intended to provide limited liability for protection for founders. Owners’ personal assets are protected, and instead, liability for debts and obligations of the business move from the entrepreneurs into the company itself.
- LLCs offer pass-through taxation; the LLC’s owners generally pay personal income taxes on the income of the business.
What are C corporations?
A C corporation is an entity designed to act as an abstraction layer between the operators of the business and the owners of the business, who may or may not be operationally involved. Ownership is tracked by shares, with each share corresponding to a defined portion of control of the business and entitlement to the economic upside of it. Owners are called shareholders.
Many companies that are household names are C corporations; one can own shares at Google without having any responsibility for working there. This assumption that control and ownership may be separate flows through the mechanics and regulation of C corporations. The state of Delaware has a highly developed body of law governing corporations that can lead to a high degree of predictability in the event of a legal dispute.
There are a few characteristics that are common to C corporations:
- C corporations are intended to provide limited liability protection; shareholders are generally not individually liable for the debts and obligations of the company.
- C corporations are assessed corporate taxes on their own profits (and have extensive filing obligations). Shareholders are taxed separately if the company distributes dividends to them (or if it pays them a salary, in the case of employee owners).
Similarities between LLCs and C corporations
Both LLCs and C corporations are companies. In the United States, third parties such as the government and companies you may wish to do business with are generally happy to deal with both types of companies; this is not true in some countries (where the local equivalents of LLCs may be at a commercial disadvantage relative to local equivalents of C corporations).
Both LLCs and C corporations are intended to limit the liability of owners and officers for the acts of the company and for debts that the company may have.
Both LLCs and C corporations can be parties to contracts, can own other companies (and be owned by them in turn) or virtually any other asset, can get banking services, and can generally operate businesses.
Assets and intellectual property
LLCs are chosen by many founders of side projects, small teams, bootstrapped businesses, or businesses that don’t know what they want to be when they grow up yet. (They can also scale to support businesses of almost any size. Basecamp is an LLC, for example. Facebook started as an LLC and converted to a C corporation later.)
One reason why LLCs can be well suited for side projects is because money and intellectual property (IP) can flow relatively freely between the members of an LLC and the LLC itself, often without the tax consequences that would result if the transactions happened in a C corporation, and often with a minimum of ceremony.
This is conceptually possible with a C corporation, but it involves more record keeping and (potentially) thorny tax considerations, particularly with regard to intellectual property, for instance. Most major actions of a C corporation also require some ceremony, such as formal resolutions of the company or votes of the stockholders; LLC operating agreements often empower the owners and/or managers to simply act.
LLCs are considered pass-through entities for the purpose of US taxation; they don’t file taxes in their own right, but have their income reported on the personal income tax returns of their owners. C corporations file their own tax returns. (Somewhat confusingly, C corporations can sometimes elect pass-through status, and LLCs can elect to be taxed like a corporation, but these are not their default treatments.)
Money flowing through an LLC is taxed at the level of the owners of the LLC; money flowing through a corporation is taxed at both the corporate level and additionally when it passes to the owners (either as salary or as a distribution of profits).
The different tax treatment of these entities can have interesting implications, particularly if the company is making losses, as many companies do early in their lives. A C corporation that makes a loss in any given year generally carries the loss against future tax years, where it can be used to offset future profits. A loss earned by an LLC may generally be used to offset income of the owners during the same tax year—for example, income from employment.
Consider the case where a company spends $10,000 in its first year in operation and has no revenue. A C corporation would likely have to defer that $10,000 loss to a future year to gain any tax benefit. An LLC might be allowed to reduce its owner’s total income by $10,000; this could result in decreasing the owner’s income tax bill by several thousand dollars. For someone working in technology in the US, this could result in them getting a substantial refund, which they could use to fund the business’s growth or for any other purpose—it’s their money.
Neither the United States nor the state of Delaware currently imposes a citizenship or residency requirement on the owners of LLCs or C corporations. That said, owning an LLC can expose nonresident or noncitizen owners to very complicated tax situations. Nonresident US citizens may be obligated to file US taxes on the income that their LLCs earn and also have to consider how that income will be taxed in their local jurisdiction.
For example: consider an LLC with two owners, one in the United States and one non-US citizen in Japan. The owner in Japan will likely be taxed on their income from the LLC by the United States. The owner in Japan may also be taxed in Japan on the same income. This substantially increases the complexity of their tax reporting.
Professional investors overwhelmingly prefer investing in C corporations versus investing in LLCs. To quote the Orrick Legal Guide for Stripe Atlas:
[M]any types of investors will not be interested in (or may be legally barred from) investing in LLCs because of the income and loss pass-through nature.
The extreme flexibility available in the LLC form also means that investors attempting to invest in one will have to do substantial legal due diligence to ensure that they are buying what they expect to be buying. Many investors do not want to do substantial expensive legal work as a condition of making an investment; they prefer to make investments in standardized companies under standardized terms. C corporations are much better suited to this preference.
In the event that one receives an offer of investment as an LLC, one may be requested by many investors (including, for example, Y Combinator) to convert to a Delaware C corporation as a requirement of taking the investment before the investment is made.
Both LLCs and C corporations can have employees. While in principle it is possible to give an employee ownership but not control over an LLC, this is nontrivial. C corporations have well-understood mechanics to issue employees equity or options for equity, with well-understood tax consequences and cultural and infrastructural support for this form of ownership throughout the tech industry.
Employees and advisors are likely much more comfortable with receiving equity than they are becoming members in an LLC, which could complicate their own tax situations for the length of the LLC’s life (even if, for example, they leave the employment of the LLC).
Vesting is a mechanism by which founders or employees of a company earn their ownership over time.
Stripe Atlas LLCs do not include a vesting schedule for equity. While corporations have a clean way to distinguish partners in the enterprise from owners, these concepts are intrinsically commingled in LLCs. An owner departing an LLC may require a negotiation between the departing partner and remaining partners regarding the terms of the separation (though the Stripe Atlas LLC has some terms to address this process). Some companies will want this to be a clean break, potentially with the remaining parties buying out the departing partner’s interest. Some may want to continue paying the departing partner a portion of the profits. These decisions are complicated and often depend on companies’ situations and the desires of their owners.
Norms for vesting are also not as established in LLCs as they are in C corporations in the tech industry; many LLCs are formed between family members (where relationship considerations may trump contractual arrangements), departures which do not result in the partnership dissolving are rarer, and ownership without control would not be as valuable as it frequently becomes in C corporations, which often contemplate operating at a materially larger scale.
Converting an LLC into a C corporation
LLCs can generally be converted into C corporations. (In principle, C corporations can convert into LLCs, but this is rarely done.)
Because LLCs are governed by contractual arrangements between the members, de-risking the conversion process for an LLC generally requires extensive legal review, which increases the monetary and time costs of converting.
Stripe Atlas LLCs have their operating agreements written to anticipate a possible conversion. There is a defined process to start a conversion. The ownership is tracked in units that can map to issuance of shares in a future C corporation. Orrick, which has substantial experience in startups, has outlined the conversion process and provided annotated templates in their legal guide that Stripe Atlas users can customize for conversion.
Where is the LLC formed?
Each state of the United States can form LLCs and C corporations, irrespective of where the founders live or where the actual operations of the company take place. Each state attempts to create a product offering for their LLCs and C corporations that makes them attractive for the purpose of attracting fees and economic development locally.
All Stripe Atlas LLCs at present are formed in the state of Delaware and may require registration as a “foreign” LLC in the owners’ state(s) of residence or operation. This is typically a straightforward process requiring a modest fee per year. Regulations for founders living outside the US vary widely; please consult a local accountant or attorney or your local government.
Orrick’s legal guide describes some of the benefits of forming LLCs in Delaware:
Delaware LLCs have the benefit of being simple to form, extremely flexible (with few restrictions on management and governance arrangements), and more familiar to parties you will interact with. In addition, the process of converting a Delaware LLC to a Delaware corporation, should you ever decide to do so, is straightforward and common enough that there are standard forms addressing most elements of the process.
The Stripe Atlas LLC in brief
Some features of the Stripe Atlas LLC are common to many LLCs; some are customized for the needs of technology founders.
You should read the entire operating agreement before you sign it, because it is a legal contract, but here is some information about its terms:
- The LLC is organized under the laws of Delaware.
- The Stripe Atlas LLC is managed by the managers, allowing day-to-day decision and management responsibility to be distinct from ownership (being a member). The company can have non-owner managers or owners who do not have management responsibilities.
- The Stripe Atlas LLC contains an IP assignment in its operating agreement assigning relevant IP that has already been created and is held by the members to the LLC at the time the LLC is formed.
- Ownership in the Stripe Atlas LLC is tracked via 10,000,000 units, which function similarly to shares and which represent a simple ownership stake of the company with only a single class of owner.
- The Stripe Atlas LLC supports adding new owners (via unanimous consent of existing owners).
- The Stripe Atlas LLC supports removing owners (via unanimous consent of all owners).
- The Stripe Atlas LLC includes language to simplify the process of conversion to a Delaware C corporation.
- The Stripe Atlas LLC does not include vesting of ownership, for reasons discussed later in the legal guide.
All Stripe Atlas LLC users receive the Orrick legal guide that provides in-depth information about LLCs, C corporations, the operating agreement, and other templates used with Stripe Atlas.
Whether you want to form a C corporation or an LLC, Stripe Atlas can help incorporate your startup. Start your company in a few clicks, and get everything you need to run your business.
This guide is not intended to and does not constitute legal or tax advice, recommendations, mediation, or counseling under any circumstance. This guide and your use thereof does not create an attorney-client relationship with Stripe, Orrick, or PwC. The guide solely represents the thoughts of the author and is neither endorsed by nor does it necessarily reflect Orrick’s belief. Orrick does not warrant or guarantee the accurateness, completeness, adequacy, or currency of the information in the guide. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular problem.