When starting a business, a key consideration is what type of business entity to form. Options include corporation, limited liability company (LLC), partnership, limited partnership (LP) or limited liability partnership (LLP). This post is about C” corporations and “S” corporations.
1. C Corporations and S Corporations
A corporation is initially formed by filing Articles of Incorporation with the California Secretary of State and preparation of other formation documents. If the shareholders do not elect to be treated as S corporation, income from the business may be subject to double taxation at entity level and taxed again on distribution to the shareholders.
Non-tax formalities for formation of an S corporation are identical to C corporation (i.e., filing of Articles of Incorporation with the California Secretary of State and preparation of other formation documents). If all the requirements are satisfied, shareholders are taxed instead of the corporation. Income from business subject to single level of taxation. Shareholders are limited to US citizens or resident individuals, certain trusts, and certain tax exempt entities.
2. Liability for Entity Debts
Shareholders of both C and S corporations have limited liability for debts of the business.
3. Participation in Management
In both types of corporations, Directors and Officers have responsibility for the management of the business. Shareholders typically are not entitled to actively participate in management unless they are directors or officers or an election is made to operate as a statutory close corporation.
4. Transferability of Interests
In a C corporation, Securities law restrictions on transfer and restrictions may be imposed by a Shareholders’ Agreement, if any. For an S corporation, Securities law restrictions on transfer and restrictions may also be imposed by a Shareholders’ Agreement, if any. Shareholders may agree not to make any transfers that would lead to termination of S corporation status.
5. Ability to Raise Capital
S corporations have a limited ability to raise capital. These entities are limited to a maximum of 100 shareholders and one class of stock. Shareholders in a C corporation have a greater ability to raise capital by public offering, venture capital funding or issuance of different classes of stock with different several levels of rights.
Electing to operate as an S corporation provides owners with a different way of being taxed compared to a traditional C corporation. A regular C corporation is treated as a separate taxable entity by the IRS. A C corporation is taxed at the corporate tax level, and then taxed again at the personal income tax level when dividends (or payments) are made to the shareholders. Conversely, as an S corporation, the income and losses of the company are passed through to the shareholders and reported once on their personal income taxes. It is crucial to consult with a tax adviser regarding the tax consequences of each type of entity for the business.
7. Exit Strategies
Each type of corporation can and should develop exit strategies and methods for succession planning including the following:
- Merger & Acquisition (M&A): This typically involves merging with a similar company or being bought by a larger company.
- Sale of the Business: This is a way to “cash out” to pay investors, yourself, retire etc. A sale can also be accomplished by a graduated sale to trusted employees or family members over time.
- Keep the Business: If the business is stable with a steady revenue stream, pay off investors and find someone trustworthy to run the business and use the remaining cash to fund a new business venture.
- Liquidation and Close. Another option is to close the business and liquidate.
Consult with an Attorney to Make the Best Business Decision
Discuss entity options with an experienced business lawyer. We effectively and successfully guide businesses through the details of entity selection and operational decisions so the business can make informed decisions designed for success. Call Lisa Wills, Law Offices of Lisa D. Wills at (925) 463-9000 or send an email to get solid guidance to make good business decisions.
Call Lisa Wills, Law Offices of Lisa Wills at (925) 463-9000 or send an email to get professional legal guidance to meet your business goals and help your business be successful.