One of the most important decisions to make when starting a business in California is to pick the right legal structure. Two popular options are Limited Liability Companies (LLCs) and Corporations. Both of them offer liability protection and have distinct advantages, but they significantly differ concerning formation, management, and taxation and compliance requirements. Here’s a breakdown of the key differences to help you decide which is best for your needs.
1. Formation and Legal Requirements
LLC: It is relatively easy to start an LLC in California because the process of filing Articles of Organization with the California Secretary of State, sketching out an Operating Agreement which contains the governing rules of LLC and registration costs is the same. LLCs can design their own management structure and are able to regularly elect the owners as the governing body or install managers.
Corporation: Formation of a corporation includes the submission of Articles of Incorporation, drafting the corporate bylaws and share issuance to the shareholders. California requires more formality, for example, a corporation should schedule regular board meetings, write down shareholders' meetings, and pass resolutions. The governance structure is rather strict and involves a board of directors, officers, and shareholders.
2. Management and Control
LLC: LLCs are flexible in management. They can be directly run by the members where all the members are entitled to vote or managed by a specific member of the LLC. This flexibility is the reason why LLCs are a favorite to small and family-owned businesses.
Corporation: Corporations have a more formal management structure. The board of directors is elected by shareholders and is responsible for overseeing major decisions and corporate policies. The board appoints officers (such as a CEO, CFO, and Secretary) to manage daily operations. This structure is more suitable for larger businesses or those seeking investment.
3. Taxation
LLC: California LLCs have an option to choose from different methods of taxation. As a default, an LLC is taxed as a pass-through entity so the profits and losses go through the owners' personal tax returns and thus are able to bypass the double taxation. However, this also means that LLCs are susceptible to an $800 annual franchise tax and probably a gross receipts tax. (according to their income).
Corporation: Corporations have to pay taxes twice, one is at the business level and another one is the dividends delivered to shareholders. Still, California introduces that Corporations can elect for S-corporation eligibility (if they fulfill the qualifications) and thus opt for the passing by treatment like LLCs. Similarly, C-Corporations are not eligible for such a treatment and must deal with issues of dual taxation.
4. Compliance and Record Keeping
LLC: LLCs have less compliance requirements. California requires LLCs to file a Statement of Information every 2 years and pay annual fees, but no formal meetings or extensive corporate records are required. Good for smaller businesses.
Corporation: Corporations have more compliance requirements. They must have annual shareholder meetings, keep detailed minutes, adopt corporate resolutions and keep a full set of corporate records. More time consuming and costly but more oversight and accountability.
5. Liability Protection
LLC: Both LLCs and corporations offer liability protection but in different ways. LLCs protect the personal assets of the members from business liabilities and debts as long as the LLC is properly maintained and operated. Members are not personally liable for the company’s actions or debts.
Corporation: Similarly, corporations protect shareholders from business debts beyond their investment in the corporation. But failing to maintain corporate formalities can lead to “piercing of the corporate veil” and expose personal assets to liability.
6. Raising Capital
LLC: Raising capital is more difficult for an LLC compared to a corporation. LLCs can add new members and raise money through member contributions but they can’t issue stock which limits their ability to attract investors.
Corporation: Corporations have an advantage when it comes to raising capital. They can issue different classes of stock making them more attractive to investors and venture capitalists. This is one reason why many larger businesses and startups prefer the corporate structure.
Summary
Choosing an LLC or corporation in California depends on many factors including your business size, goals, management style, tax considerations and plans for raising capital. LLCs are good for small businesses and simpler management while corporations have a more structured governance and more opportunities for capital raise. Consult with an attorney or tax advisor to decide what’s best for you.
