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
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.
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
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
Stock options and restricted stock can be granted to employees
Employees can be granted profits interests
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:
- Is there an exit plan for the business and what is it?
- Who will be investing in the business?
- How will the business be capitalized?
- 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
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
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
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.