C corporation This is the most common structure among larger companies. "It's the favorite form for startups looking for eventual venture capital investors or a public offering," Rampell says. That's because of its simplicity.
But he and others caution against blindly adopting this structure. For example, a startup that suffers losses during its first two years would do better as an LLC, Rampell points out. That's because LLC members will be able to write off the losses on their personal taxes.
"In a C corporation developing-year losses get wasted until you make a profit," he explains. "And in an S corporation you can only deduct the money you've invested or directly loaned to the company."
The journalist Murphy started a C company called FXOTICA.com in 2000 as a currency trading service. That idea didn't succeed, and he hopes to re-launch it as an African business development service.
If he was starting now, Murphy would reconsider the C corporation choice. "In the early stages I spent tens of thousands of dollars to set up structures and issue shares," he says.
"It gets very expensive. In those days, people were raising a lot of money with the dreams it would turn into a very large business. In today's environment, the expenses for that structure are prohibitive. As a small business, you want to keep your legal and accounting expenses down."
- Potential users: Businesses that want to go public or garner venture capital investments.
- Advantages: Limited liability, flexible ownership structure, tax deduction for dividends, no self-employment tax.
- Disadvantages: Expensive to establish and maintain, double taxation.
Some C corporations try to avoid the double taxation problem by giving out all their profits in compensation. But that's not a wise strategy. "You get into issues of unreasonable compensation," Brenner says. "The IRS can say your compensation is too high, that some of it is disguised dividends."
Bottom lineMany experts say LLCs represent the top option for most startups. "One of my partners has a saying: 'If you go to a lawyer, and he sets you up as anything but an LLC, he's committing malpractice,'" Brenner says.
Gary Schildhorn, a lawyer for Eckert Seamans in Philadelphia, cites an anecdote in which his clients benefited from the LLC structure. Two salesmen who had worked in a staffing company business wanted to start their own firm.
"They could bring their old accounts to the new company, and they also wanted to include a third colleague who could bring a lot of knowledge and experience to the table," Schildhorn says. "But the third guy had a noncompete contract with his old firm lasting for 12 months."
They started an LLC with only the first two as members. But the third guy was granted an option to purchase a percentage of the company, and once he did so, he became president.
Thus, thanks to the flexibility of the LLC structure, "they were able to assure him he'd be part of the company, even though he was restricted from joining them for a few months," Schildhorn says.