Startups: You Should Form Corporations, Not Partnerships. Here’s Why.
Let’s say you and your friend have a great idea for a new product. You’ve brainstormed how you want to package it, decided what online platforms you’ll use to reach your customers and created a business plan. Though you might introduce your friend as your “business partner,” that title can be great in the vernacular…but not the best choice for a business entity. Here are some reasons why.
Corporation vs. Partnership
Many people who are starting a business with a friend or fellow visionary think that the terms “partnership” and “corporation” are interchangeable. After all, doesn’t it just mean that two or more people own and run the business? Actually, these are two very different types of business entities that should be considered carefully.
In startup corporations (like S Corps or C Corps), the company is owned by shareholders, not partners. One of the most important benefits of creating a corporation is that the company is considered a separate entity from the individuals. This means that if the company goes into debt or is sued, the shareholders’ personal assets (such as houses, cars and bank accounts) are not at risk.
Corporations have other benefits that partnerships do not. First, corporations can sell stock in the company to raise money while partnerships can’t. Second, corporations have some tax benefits over partnerships. For example, corporations don’t owe taxes on earnings paid as compensation to employees or shareholders since these payments can be deducted as business expenses.
It is also important to think about which entity to choose for the company’s long-term advantages. What do you envision as the future of the business if the unexpected happens and one of the shareholders can no longer be involved due to death or illness? A partnership may dissolve in these circumstances, but a corporation can be readily distributed to family members.
One upside to partnerships is that they are easier to form and aren’t as expensive and complicated to set up as a corporation. However, if you do form a partnership rather than a corporation, your personal assets can be seized if your company goes into debt and can’t pay its bills. Additionally, partnerships can’t sell stock in the company and need to rely on loans or add more partners if more funding is needed.
A partnership is also are run differently than a corporation. Corporations have a managing board of directors that are involved in the decision-making process, and the majority wins. With partnerships, the partners are the hands-on decision makers and need a unanimous vote when policy and structural decisions need to be made.
Should I Choose a Corporation, Partnership or LLC?
If you aren’t sure whether you should choose to create a corporation or partnership, consider starting an LLC. There are several reasons why a Limited Liability Company (LLC) is the most common entity that startups choose:
- An LLC protects your personal assets without the additional expenses or complicated paperwork required for a corporation.
- Depending on the size of your company and the number of employees you have, there are various tax advantages to filing as an LLC, S Corp or C Corp. As an LLC, you have the option to choose how you want to be taxed (either with pass-through taxation or as a corporation) to receive the lowest tax rates or highest deductions. You should discuss these options with your accountant as you start and grow your business.
- The distribution of profits can be a sensitive issue between partners. In partnerships and corporations, profits and losses are in direct proportion to the percentage of the company each partner or shareholder owns. As an LLC, this is more fluid depending on the changing roles of those who are performing the tasks. For example, let’s say that you start a corporation with a friend and you share the profits 50/50. However, if that friend begins to contribute less, you’ll either have to share the profits equally or rework structural agreement. As an LLC, you have more freedom to dictate how the finances are distributed; a shareholder can receive reasonable compensation if they are also an employee of the company.
If you still have questions or concerns about which type of entity you should choose, contact Incfile today. Our experts can help you to determine what type of business entity is right for you.
Even better, we’ve helped over 150,000 businesses worldwide, and we’re excited to help you manage your company, too. To get started, we’ll ask you for your contact information (which is required to start a business by the respective Secretaries of State), and then we’ll ask some basic questions about your company. Then, we’ll fill out and send in your documents so that you can officially conduct business as your own entity. It’s that easy to form your business with the government and protect your assets. Why not call today?