Entrepreneurs often face a fundamental choice: LLC, corporation, or partnership? Each structure offers different advantages for liability protection, taxation, management, and growth potential. The right choice depends on your specific business goals, ownership structure, and long-term plans.
Understanding the key differences helps you select a structure that serves your needs now and as your business evolves.
Limited Liability Companies (LLCs)
LLCs are the most popular structure for small businesses, combining liability protection with tax flexibility. Owners (called members) generally aren't personally liable for business debts. Profits pass through to members' personal tax returns, avoiding corporate-level taxation.
LLCs offer maximum flexibility in management and profit allocation. Operating agreements can customize nearly every aspect of how the business runs. Members can participate equally, proportional to ownership, or according to any arrangement they choose.
Formation is straightforward: file articles of organization with the state and create an operating agreement. Annual requirements vary by state but are generally simpler than corporate formalities.
Corporations
Corporations provide strong liability protection and are ideal for businesses planning to raise capital or go public. Shareholders own the corporation, a board of directors oversees it, and officers manage daily operations.
C corporations face double taxation—corporate income tax on profits, then individual taxes when dividends are distributed. However, they can retain earnings at corporate rates, offer stock options, and attract institutional investors.
S corporations are a special tax election (not a separate entity type) that provides pass-through taxation while maintaining corporate structure. S corps have restrictions on ownership: no more than 100 shareholders, only individuals (not entities) as shareholders, and only one class of stock.
Partnerships
General partnerships form automatically when two or more people conduct business together. They're simple but offer no liability protection—each partner is personally liable for partnership debts and each other's business actions.
Limited partnerships (LPs) have general partners who manage the business and bear liability, plus limited partners who contribute capital but don't participate in management and have limited liability. LPs are often used for investment structures.
Limited liability partnerships (LLPs) provide liability protection to all partners but are mainly available for professional service firms like law and accounting practices in most states.
Liability Protection Comparison
Both LLCs and corporations shield owners from personal liability for business debts and lawsuits against the business. General partnerships offer no such protection—partners risk personal assets.
Liability protection requires respecting the entity's separateness: keeping business and personal finances separate, maintaining adequate capitalization, following formalities, and not using the entity to commit fraud.
Personal guarantees on loans and leases bypass liability protection regardless of entity type. Many small business owners must personally guarantee early-stage financing.
Tax Treatment Comparison
LLCs default to pass-through taxation (like partnerships or sole proprietorships) but can elect corporate taxation if advantageous. This flexibility is a significant LLC benefit.
S corporations avoid double taxation through pass-through treatment, but owners who work in the business must receive "reasonable compensation" as wages, subject to employment taxes, before taking additional profits as distributions.
C corporations pay corporate income tax (currently 21% federal) on profits. This may be advantageous for reinvesting earnings but creates double taxation when distributing to shareholders.
Management and Control
LLCs can be member-managed (all owners participate) or manager-managed (designated managers run operations). Operating agreements customize management extensively.
Corporations require formal structure: boards of directors, officers, annual meetings, and recorded minutes. This structure provides clear governance but demands ongoing compliance.
Partnerships are typically managed by partners according to partnership agreements. General partners control operations; limited partners' involvement is restricted to preserve their liability protection.
Investment and Exit Considerations
If you're seeking venture capital or planning an eventual public offering, C corporations are strongly preferred by investors. The familiar stock structure and ability to issue multiple classes of shares suit investment rounds.
LLCs can be converted to corporations when seeking investment, but this triggers tax consequences and complexity. Plan ahead if investment is likely.
For businesses that will remain privately held with stable ownership, LLCs provide simplicity and flexibility without the need for corporate structure.
Getting Legal Help
Entity choice has long-term consequences for taxes, liability, and business operations. A business attorney evaluates your situation, explains trade-offs, and recommends the structure that fits your goals. They draft essential documents—operating agreements, bylaws, partnership agreements—and ensure proper formation. The right structure from the start protects you and positions your business for success.