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In what scenario would a corporation be preferable to an LLC?
In a nutshell, it is a corporation’s ability to raise money, scale, and issue stock that gives it advantages that no other business organization has. The corporate business structure is ideal large-scale investment – for hundreds, thousands, or even millions of people to invest money into a business. It is no coincidence that many of the most valuable companies in the world are corporations, and this is a direct consequence of the fact that corporations can issue shares.
But before we dive into advantages of corporations, let’s look at the downsides of a corporation compared to an LLC.
Downsides to Corporations
Forming and administering a corporation is more costly and complicated than an LLC, or most other business organizations. The state filing fees are higher, lawyer fees are higher, there is more paperwork, regulations, and corporate taxes are more complex.
For example, on corporate taxes – a corporation must pay a corporate tax rate on its income, but its shareholders must also pay capital gains tax when they sell shares. If you are a manager or owner drawing a salary from the corporation, you pay income tax on your salary.
In contrast, LLC income can essentially be taxed like a sole proprietorship or a partnership if there are multiple members. For a start-up or small business, keeping track of all the different corporate taxes can be a headache compared to the simplicity of an LLC.
In addition, while a corporation provides you with limited liability protection, so does an LLC.
And, as a corporation, when you issue shares of stock, you are regulated and governed by securities law – a compliance headache. Finally, you will be paying much, much more to lawyers and accountants to form and maintain a corporation than an LLC.
So, why would anyone want to form a corporation?
I think the biggest benefits of having a corporation over an LLC come from its potential to scale. To me, there are three striking ways that a corporation has an advantage over an LLC.
- Ease of Investment
- Share Liquidity
- Longevity
1. Ease of Investment
If you aim to raise a lot of money for your business from dozens, hundreds, or thousands of investors, a corporation holds the edge in its ability to raise capital.
Corporations differ from LLCs in that they issue stock, with the ownership being held by the stockholders. Owners of an LLC are called members, and while LLC members can divide ownership of the LLC amongst themselves by percentages, they cannot issue stock.
So, can LLC members buy and sell membership stakes in their companies? Sure, but the process is much more cumbersome than buying and selling stock on larger scales.
This gives a corporation a distinct edge – a corporation can issue new stock to investors rapidly and with precision. It’s easy to issue 100,000 shares of stock in corporate bylaws to be given to 100 new investors in exchange for capital. When you are trying to grow a business and new investors are trying to give you money every day, selling stock is fast and efficient.
It’s harder to split, track, and calculate LLC membership stakes for 100 new investors if it requires updating and ratification of a new operating agreement every time. And remember, you can’t buy, sell, and trade LLC members themselves, as that would essentially be trading securities.
Corporations can also issue classes of stock – for example, corporate bylaws could establish a Class A stock with voting rights and a Class B stock with less, or none at all. Could you do something similar with an LLC? Yes, but again – it’s much more cumbersome. Corporations were designed for this sort of thing.
So, if you are just raising money from a few investors, or are an early-stage company, an LLC is likely a better business structure. But if you plan on going public or raising money from many investors, consider forming a corporation or converting from an LLC to a corporation.
2. Share Liquidity
Corporate shares tend to be very liquid. Think about the New York Stock Exchange, and the millions of corporate shares traded every day. These are traded instantly from computers and smartphones to people all around the world.
No other business organization has the ability to issue stock and trade ownership like a corporation.
This liquidity makes corporate stock an excellent investment that you can cash-in and cash-out of fast. This increases the value of corporate stock tremendously.
3. Longevity
Corporations like Coca-Cola or Ford were both founded over 100 years ago, and yet they are still some of the largest companies in the world. Over the lifetime of the companies, thousands of employees came and went. Leadership has changed dozens of times. Yet still, these companies have persisted, along with many other corporations.
The structure of corporations, with boards of directors and shareholders, create the ability for an organization exist long after its founders have left the companies.
Longevity is well-correlated with value. While this applies to any company, a company that is able to be run by its investors instead of a highly-involved founder is more “sellable” and tends to hold a higher valuation. The unique structure of a corporation can help achieve this goal.
Conclusion
While a corporation comes with higher administration and legal costs, its ability to issue shares to stockholders is its key advantage over other business organizations.
If you are planning to take on many different investors and are prepared to take on the higher formation and maintenance costs, forming a corporation could be very beneficial to both raising money and increasing the valuation of your business.
If you are forming a business with a lower budget, starting as an LLC, and then later forming a corporation could be a useful strategy. Just make sure you begin with the end in mind, and structure your operating agreement in a way that it can smoothly be converted into a corporation.