Chapter 1. Forming a business entity: Delaware C-Corp or LLC?
So, now it’s time to define the underlying tax structure of your startup. Delaware C-Corps and LLCs are the most common and popular business entities. While that narrows down your options, each has advantages and conditions that lead to different outcomes.
If you choose to become a Delaware C-Corp
This means you formed your corporation in the state of Delaware. The state of Delaware has flexible and mature business laws that help support hyper-growth companies. Nearly all investors invest solely in startups that are a Delaware C-corp because the format is already set up for mergers and acquisitions. No legal language has to be changed to invest so it makes life easy for potential investors. Most startups form Delaware C-corps to make fundraising easier. The tax rate for C-corp is 21%.
Tax implications to keep in mind
All C-corps are double taxation entities. That means any profits made are taxed on the company and the individual level. Unlike LLCs, as a C-corp owner, you will pay taxes on company profits and then pay taxes again on salaries and wages as an individual.
Why Delaware C-Corps are better for raising venture capital:
1) Easy to sell and transfer ownership
The legal structure of C-corp is designed to sell and transfer ownership (equity) without altering the existing legal structure.
2) Easy to scale and grow
Unlike S-corp (limited to 99 shareholders), there are no limits on how many shareholders a C-corp can have.
Remember: When it’s time to issue equity to employees, you can do it more seamlessly as a C-corp than other entities.
If you choose to become an LLC
LLC is short for Limited Liability Company. They’re easy to form and shield you from liabilities. With an LLC, all profits flow back to the owner. The tax bracket depends on other income and earnings. It could be anywhere between 21% to 37%. The difference is, with a Delaware C-Corp, all profits stay within the company and there’s only one tax rate—21%.
Tax implications to keep in mind
LLCs are pass-through taxation entities. We touched on this briefly, but it basically means all profits and losses are passed onto you, the owner. On an individual tax level, you and your company get taxed only on the profits and losses you made. In other words, you and the company are considered one entity.
One of the advantages of “pass-through taxation entities”, is that you only get taxed once instead of twice. For example, if you made money on other investments but had a net loss from your LLC, you can use tax credits from your LLC for your personal tax return to lower the tax payment.
Change your mind? You can still switch your business entity
Even though you can, doesn’t mean it’s in your best interest. Making the switch can be very time consuming and cost you a pretty penny. It’s always better to pick the right entity type from the start and stick with it.
Choosing between LLC and Delaware C-Corp
First, assess your overall goal. Is it to grow, scale, and raise funding? Or do you plan to keep the business and with it your personal and business taxes together too? If you want investors, go with a Delaware C-Corp. If you want to keep your company for the long haul, an LLC is the way to go.
A CPA’s 2 Cents
Despite getting taxed twice, Delaware C-Corp is the top pick for startups of all shapes and sizes. Delaware C-Corps are highly scalable and easy to sell and transfer ownerships, therefore investors flock to them. Most startups prioritize raising funds (and managing cash flow) to make sure the business keeps running strong. For that, you need money. Keeping future investors in mind early on can be critical to long-term success.
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2. Set Up accounting system