Entrepreneurial Insight by Susan Schreter
Special to Seattle24x7
Q. I saw your column on forming partnerships with friends. What are the advantages of forming an LLC company versus an incorporated company? I’m going into a side-line business with a friend. Each owns 50 percent of the company. If our idea clicks, the business could generate $1 million plus recurring royalties. Which is better for us?
A. I like any business that has the opportunity to generate a neat million plus ongoing income. Who wouldn’t want to have a piece of that action!
While you think you and your friend are the only partners in your business, you do have other silent but highly compensated partners who will share in your potential success. Let me introduce you to your new lifelong partner Uncle Sam!
One question that may make your decision easy is this: Do you want to pay your taxing partners once or twice on the same amount of profits every year? Most startup entrepreneurs would want to keep as much of their hard earned profits as possible by organizing as a limited liability company or “LLC”, general partnership or “S corporation”, rather than as a standard “C corporation.”
Here’s how it works. A limited liability company or LLC allows business profits to bypass traditional corporate taxes and pass through to the LLC’s owners or “members.” You would report your LLC-related income on your personal income tax return. Equally, you would be able to apply any startup LLC-related losses on your personal income tax return.
In contrast, business profits in a standard C corp are taxed by the federal government and again by most states. Then to the extent that you and your partner take out the profits in the form of dividends or bonuses, you have to pay Uncle Sam once again. Nasty isn’t it!
Both LLC’s and C corps provide owners with some limitations of liability. For example, if your business obtains debt without signing a personal guarantee, you and your friend would generally not be personally liability for missed payments. It’s important to note that exceptions to liability limitations may exist in tort claims involving negligence or fraud.
Big concept entrepreneurs seeking angel or venture funding should just organize a C corp. Multiple rounds of venture funding often involve the issuance of several classes of common and preferred stock – which is easily handled in a C corp structure. Many sophisticated investors crinkle their noses at LLC’s and won’t invest until the structure is changed – at the entrepreneur’s expense. Employee stock options are also easily administered in C corps.
The set up and ongoing administrative requirements of an LLC are easier than a C corp. Most states offer online tools to register the business name and develop an LLC’s “Articles of Organization.” Visit sunbiz.org to download LLC filing forms for Florida companies.
If you decide to organize an LLC, I strongly recommend that you hire a seasoned business-oriented attorney to develop your LLC’s “operating agreement.” This agreement should carefully define voting rights, responsibilities of the owners, the procedures for buying or selling member shares in the business, or even how to one day dissolve the business.
Given the high potential of your business, it is best to talk to your accountants too. Ask probing questions, including if your personal situation may require you to pay self-employment tax on your share of LLC profits.
I never mind paying for skilled accounting and legal guidance. When embarking on a new venture, it’s reassuring to know the first steps forward are in the right direction. Go make your million! [24×7]
Build the business of your dreams. Send your fundraising and small business management questions to firstname.lastname@example.org.