Small Business Checklist Series: Colorado Corporation vs LLC

corporation-llc-business entity-comparison

Introduction: Is your Colorado business better suited in an LLC or a Corporation?

The following is a brief comparison of a Colorado corporation vs an LLC with a few pros and cons of each and which entity structure might be better under certain circumstances. Not discussed here are entities such as sole proprietorships, limited or general partnerships, or the differences between c-corps and s-corps. Also, when discussing corporations, this article refers to c-corps. 

Basic comparison of corporations vs LLCs

 

Corporation

LLC

Organization

File articles of incorporation with the secretary of state. Must file a periodic report each year

File articles of organization with the secretary of state. Must file a periodic report each year.

Governing Documents

By-laws: Contains some material provisions such as appointment of directors but corporations are governed primarily by the Colorado Corporations and Associations Act

Operating agreement: Agreement/contract between members of the LLC

Form of Equity

Shareholders of a corporation hold stock. There can be multiple classes of stock with different rights and preferences. Transferability of shares can be restricted through shareholder agreements

Members hold membership interests which can be assigned or transferred by a member in whole or in part

Liability

Shareholder’s liability is limited to the amount of capital contributed for the shares

Members are only liable up to the amount of capital contributed for the membership interests

Employee Incentives

Stock options and restricted stock can be granted to employees

Employees can be granted profits interests

Capitalization

Raise capital by issuing shares according to the number of authorized shares. The number of authorized shares can be increased by amending the articles of incorporation

Raise capital by issuing membership interests. Unless restricted by the operating agreement, there is not a limit to how much equity an LLC can issue

What are the goals of the business?

It is important to understand the goals of the business as this will heavily influence choosing between a corporation vs an LLC. Questions to ask include:

  1. Is there an exit plan for the business and what is it?
  2. Who will be investing in the business?
  3. How will the business be capitalized?
  4. Do the owners expect the company to grow and be sold or will they likely continue to operate it themselves?

Pros and cons of corporations and LLCs

Corporation

Pros

Cons

Investors such as venture capital firms are familiar with the corporate form and are more likely to invest if that is the goal

Must follow corporate formalities

Ability to grant stock options to employees which are well known

Double taxation (corporate tax + distribution tax)

Multiple classes of stock easy to issue and navigate

Less flexibility than an LLC

LLC

Pros

Cons

More flexibility in structuring the business through an operating agreement

Investors are less likely to invest in an LLC because of less familiarity

Pass through taxation

Employee incentives in the form of profits interests which can get complicated

Takeaways

When deciding to use a corporation vs an LLC, the classic lawyer answer is: it depends. If the business is looking to raise capital early on from outside investors and potentially make an exit one day (thinking start-up), then the corporation is the better option. However, if the business is more of a mom and pop shop that is not looking for venture capital investment, then an LLC offers flexibility and good tax benefits.

Please reach out to Miles Williams at miles@mwlegalgroup.com with any questions regarding your business and take a look at our services!