If you are thinking of starting a technology company that you already know, there are many things to consider. The legal structure for company formation is one of those critical factors and has a significant impact on whether or not you will be successful.
Most SaaS, AI, and IoT companies are corporations. But what if a tech startup uses the LLC structure? Why should a founder consider this idea? However, that does not negate the many advantages that a corporation offers.
This article examines all the major commercial structures and highlights the important benefits of each, and in particular of LLCs.
LLC versus sole proprietorships and general partnerships
SaaS, AI and IoT companies are capital intensive startups; It’s almost impossible for your startup to take off if you run it as a sole proprietorship or a general partnership.
And this is not only due to the lack of liability protection, although it is an important factor that attracts investors. As a sole proprietorship, your investment sources are minimal, often limited to just family members and a few close friends.
Even when you have family and friends who invest in your business, the investment amount is generally quite small. Most sole proprietorships are still small businesses. If your goal is a technology business that plans to scale, a significant investment is required.
Not to mention that sole proprietorships are less trustworthy, from an investor’s point of view, and credibility is an important factor driving investments. In essence, forming an LLC positions you to attract investors. Enterprise configuration platforms such as IncFile they have also made this process easier and more efficient for businesses.
Investors are driven by the need to minimize risks and maximize returns. But sole proprietorships and partnerships don’t have the structure to allow this. For one thing, they have no liability protection. Also, they cannot issue stocks or bonds.
LLC vs corporations
Compared to corporations, LLCs can be more flexible with investors and investments. As members, investors can choose to become co-owners of the company or just directors.
Furthermore, investors are attracted to LLCs because they can enjoy a flexible tax regime. Unless the LLC itself specifies otherwise, the profits and losses of the company are transferred to the members (owners and investors) in proportion to their contribution to the company.
And although an LLC is legally required to report its income, gains, and losses, it does not have to pay corporate income taxes on the gains.
When you contrast this with corporations, where investors pay double taxes (first the corporation pays taxes, then shareholders also pay taxes when they receive dividends), you find that LLCs are much more flexible.
Although, it is worth noting that some corporations (S body; the others are called C-Corps) can obtain a special status that exempts them from corporate taxes. Lower tax rates allow an LLC to be more flexible with finances.
However, most institutional investors (venture capital groups, for example) do not mind this structure and, in fact, prefer to invest in corporations due to protections against equity issuance.
While LLCs cannot issue stocks, they can sell bonds to investors. Bonds, which are technically a type of loan, can help a business raise the funds necessary for business growth.
Long term strategy
No founder wants to start a business that would only survive a year or two. A primary consideration in creating a tech startup is long-term strategy, based on the goals of the owner / founder, especially with regard to exit.
If the goal of a founder is to grow the business for some time and exit by selling the company, through a merger / acquisition or through an initial public offering, then the corporation structure (C-Corp) might be the best. Corporations perform better in their IPO openings, and only they can receive tax benefits through Small Business Qualified Stocks (QSBS).
However, as all founders would admit, a startup’s path of success is never clear from the start. Therefore, an early departure might not be on the table initially. Many founders like to maintain significant control over their business.
However, as a corporation, the business is effectively in the hands of investors and the founder may even be left out of the way in making crucial decisions. Even if you have a long-term exit strategy, keeping your business as an LLC protects your interest as a founder for as long as you like.
As such, it may not be too bold an idea to start your business as an LLC and then transform it into a corporation later as the business grows.
However, keep in mind that it shouldn’t be a hard and fast rule that all tech startups in SaaS, AI, IoT, and the like should start out as corporations. Definitely not.
Instead, founders should carefully examine their unique contexts and use the business structure that best supports the growth of the company.
This article has simply shown that LLCs help you make a lot of profit and can jump-start your initial growth journey as a founder.
LLCs are often considered a hybrid of sole proprietorships and corporations, and that’s for good reason. As a founder, explore all of your options to play your cards right.