Choice of Entity: Is An LLC OK?


I am frequently asked by entrepreneurs what type of entity they should form. And I usually advise startups to form as either a C corporation or an S corporation for the following reasons:

• If you plan to grant stock options to employees or contractors, it is much easier to do this through a corporation than an LLC taxed as a partnership.

• If you plan to raise funds from third parties in the future, investors typically don't want to invest in a pass through company and receive a Form K-1, and so it typically makes sense to start as a corporation (and if you elect S corporation status, terminating it prior to a fund raise is easier than converting an LLC to a corporation prior to a fund raise).

I think the advice is pretty typical of what startup entrepreneurs hear. In fact, I think the mantra from organizations around town is to form a corporation for your new business. However, it is not always the case that an LLC is a bad choice. I met with an entrepreneur recently who was going to form a new company to test an idea, to see if it had legs. He was going to be the initial, sole owner of the business. And he didn't know what he was going to discover. He didn't know if in 6 months he'd have a business or not, and one in which he would probably want to raise third party money for. In this situation, forming an LLC can be a good, inexpensive way to get started. Why?

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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