Choosing a business structure is one of the most significant decisions you must make for your startup. You can make your software development company a limited liability company (LLC) or a corporation. Each structure has advantages and disadvantages, so it is essential to consider your goals and the nature of your venture before deciding.
Additionally, the two business structures also determine the growth potential of your business, tax implications, and exemptions, among other things. Therefore, it’s a choice that should be thought over properly. This article will discuss the differences between LLCs and corporations and which should be the best choice for your software development startup.
LLC Vs. Corporation: What Are They?
An LLC is a business structure with limited personal liability for its owners and pass-through taxation. It means the owner or owners are responsible for the LLC’s profits or losses, who in turn pay taxes on them. Generally, LLCs are owned by a few individuals and have a more flexible management structure than most corporations.
A corporation is a business organization legally separate from its owners, meaning it can sue or be sued. Its owners are not personally liable for any losses or debts the company incurs. Typically, shareholders own a corporation, meaning stocks can be listed and sold on stock markets. Corporations are highly regulated and require more formal processes for matters like decision-making and management than LLCs.
Which Is Best For A Software Development Startup?
When deciding between an LLC or corporation, you must consider several factors. Here are some of them:
1. Approval Times
When setting up your startup, you want to complete the registration as soon as possible so you can start operating legally. Therefore, check how long does it take to get an LLC versus a corporation in your state.
Generally, an LLC can take between 10 business days to about four weeks before approval. The approval time for an LLC depends on the state you’re registering your startup, whether you file the registration online by mail, how long they process it, and how fast they send it back to you.
On the other hand, a corporation requires more documents, which can take more time. Depending on the state, it can be as quick as seven business days or as long as 60. Processing the paperwork takes more time. Due to the complexity of the requirements, they may send the application back for more information before it’s approved.
However, you can speed up the approval times for both structures by getting an expedited filing. This option allows you to pay extra fees to reduce the approval time by up to two days. However, some states don’t have this option.
2. Ease Of Forming
However, a corporation requires too much paperwork during registration. You must file Articles of Incorporation, shareholders agreements, bylaws, and founder stock purchase agreements. Additionally, you’ll need to hold a meeting before filing with the state as part of the formation process.
Decide how complex your startup’s structure is and whether you need to incorporate it. A corporation is the best option if other shareholders are in your business. However, an LLC might be suitable if you’re the only owner and want more control over decision-making.
3. Tax Implications
Corporations and LLCs have to file taxes, but the differences in taxation come when it comes to profits. An LLC has pass-through taxation, meaning all the profits and losses pass down to the owners, who then pay taxes.
On the other side of the table, there is no tax classification for an LLC. Therefore, they are either taxed as sole proprietorships or partnerships. The members will add profits/losses from the software development business to their income and fall in a particular tax bracket. However, some LLCs can also choose to be taxed as a corporation.
Corporations are taxed as separate entities to the shareholders. They may pay taxes at the corporate level, depending on their size and structure, before shareholders receive dividends or bonuses. However, corporations face the risk of double taxation as the shareholders also need to file taxes on their profits.
Registering as an S Corp can help avoid double taxation when incorporating your software development startup. It’s where profits and losses can be passed through to the shareholders, who then pay taxes. However, it should have less than 100 shareholders and only one class of stock.
4. Stock Classes
When it comes to issuing shares for your software development startup, a corporation can issue different classes of stock. It allows you to differentiate between founders, investors, and employees. It also provides for alternative voting rights depending on the class. Members of a corporation can also transfer their shares without much hassle.
An LLC doesn’t have stocks but “membership units.” This means that the members can only transfer their membership units with the permission of other members. Additionally, LLCs don’t have different classes of stocks, and voting rights are based on ownership or membership interest.
5. Investor And Funding Friendliness
It’s common to look for funding when developing software. However, the structure of your business determines how easy it’ll be to find investors. Most investors prefer corporations as it offers security such as personal liability protection and limited stock options.
Additionally, incorporating your startups ensures ease of share transferability for investors. They also get several tax benefits, such as Qualified Small Business Stock. An investor can exclude up to 50% in stock gain if they hold it for more than five years before selling.
On the other hand, LLCs are a great option for smaller startups. They are flexible and more informal than corporations.
Investors may get pass-through taxation benefits with LLCs. It has a more straightforward tax structure that some investors may prefer and choose to work with. Moreover, double taxation is not risky, and losses can offset profits from other businesses.
Suppose you decide to go with an LLC. The investors may need to sign a special agreement called an Operating Agreement outlining the rights and responsibilities of each member.
LLCs and corporations are two famous business structures for software development startups. As discussed in this article, several factors should guide your decision between an LLC and a corporation.
An LLC can be an excellent option for smaller startups looking for flexibility, pass-through taxation, and limited personal liability protection. Corporations can benefit more prominent startups that need to raise funds from investors as it offers more investor-friendliness and stock transferability options.
Ultimately, your structure depends on your needs, goals, and features. It’s best to consult with a business lawyer or accountant specializing in business formation to ensure you make the right decision for your software development startup.