I can tell you from experience that many food entrepreneurs struggle to understand the type of legal entity best suited for their business. If this is you, don't worry because you're not alone. In fact, there are several scenarios where you may find yourself asking, "should my food business be an LLC or a corporation?" But the answer depends on your situation and the purpose behind the need for a new entity.
Here are a few examples: a few friends decide to launch a small business, or maybe an established and successful company is contemplating creating a subsidiary to expand into a new line of business, or possibly a large, foreign company is looking to enter the U.S. market. In all of theses examples, the threshold question is: should we form a corporation or an LLC? The answer depends on the needs and wants of each business as well as on unique state laws. However, both types of entities have similarities and differences that are common in almost every state.
Below we've provided some information to help you make a decision that nearly every business should consider:
Limitation of Liability. This is perhaps the most important consideration for all businesses. Both LLC's and corporations limit an owners’ individual liability. An owner may lose its investment in the company, but an owner’s personal assets are generally off-limits. This liability protection is one of the key reasons most businesses prefer to utilize corporations and LLC's.
Ownership restrictions are minimal under the default state laws for both business types. Neither form restricts who can own shares of the company, and both forms allow 100% ownership by a single person or entity. A business should keep in mind, however, that ownership by a single person can reduce protection from personal liability in certain states. Under either form, a company may have one or more classes of shares with different rights and preferences (e.g, profit distributions, voting rights, etc.).
Taxation. How the entities are taxed is one of the most notable differences between a corporation and an LLC. Unless the owners choose to be taxed as a corporation, an LLC’s profits and losses are passed through to the individual owners. These owners pay income tax on their portion of the profits and/or losses at their personal tax rates. The LLC itself is not taxed.
On the other hand, a corporation incurs double-taxation. Profits are taxed at the corporate level at corporate tax rates. Any distributions to shareholders are taxed again against the shareholders’ at their respective individual tax rate.
Flexibility. This is also a major concern for many businesses when deciding between an LLC and a corporation. Generally, LLC's have greater flexibility under state law to craft the LLC’s operating agreement to meet their business need. An operating agreement is the document which sets the framework for and governs the affairs and operations of the company. Most state laws allow the terms of the operating agreement, rather than state statutes, to control. In other words, an LLC allows the owners to set the rules for management, voting rights, share transfers, profit distribution and other business matters.
On the other hand, a corporation must adhere to more extensive requirements, including the observation of corporate formalities that aren't required for LLC's. For example, corporations must hold annual meetings and record meeting minutes (i.e., notes from the meeting), and often require a certain amount of notice the company must provide to shareholders before holding a shareholder meeting. While this may seem more cumbersome, it does have an advantage, however, in that the rules for corporations are more predictable than an LLC. This predictability is often why investors prefer corporations over LLC's for investment purposes.
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