Choice of Business Entity: Pros and Cons of Corporations and LLCs
By Sahir Surmeli & Ryan Urban
When launching your startup, there’s no shortage of big decisions to make, but one of the most impactful at the early stages is choosing the right legal structure. Choosing the right form of entity lays the foundation for how your business will be taxed, your process for raising institutional capital, and the treatment of your expected return upon exit. The three most common types of entities are C-Corporations, Limited Liability Companies (LLCs), and S-Corporations. For most founders who intend to raise outside capital from traditional venture capital funds, a C-Corporation is most common. However, LLCs and S-Corporations provide their own unique tax advantages that may be more appropriate for certain businesses. This article provides a summary of some of the pros and cons of each entity and factors to consider as you determine which entity may be the right fit for your new venture. Consulting with a legal advisor to assess your specific situation is essential.
C-CORPORATION
When launching your startup, there’s no shortage of big decisions to make, but one of the most impactful at the early stages is choosing the right legal structure. Choosing the right form of entity lays the foundation for how your business will be taxed, your process for raising institutional capital, and the treatment of your expected return upon exit. The three most common types of entities are C-Corporations, Limited Liability Companies (LLCs), and S-Corporations. For most founders who intend to raise outside capital from traditional venture capital funds, a C-Corporation is most common. However, LLCs and S-Corporations provide their own unique tax advantages that may be more appropriate for certain businesses. This article provides a summary of some of the pros and cons of each entity and factors to consider as you determine which entity may be the right fit for your new venture. Consulting with a legal advisor to assess your specific situation is essential.
Who should consider a C-Corporation?
Founders who plan to raise money from traditional venture capital funds, tax-exempt investors or non-U.S. investors in the near future should strongly consider forming a C-Corporation. However, founders who do not anticipate raising funds in this context and who might seek to have the entity make distributions prefer to avoid double-taxation imposed on a C-Corporation, should consider an LLC or S-Corporation as a more suitable alternative in the near term.
Pros:
Institutional Investors Prefer C-Corporations – Venture capital funds, tax-exempt investors and non-U.S. investors prefer investing in C-Corporations because a C-Corporation’s income is taxed at the entity level and does not flow up to the investors (which may have subjected them to tax and filing requirements). C-Corporations also have the ability to offer preferred stock to investors to allow them to be paid ahead of all other equity holders in a liquidity event or change of control and can have other preferential rights with respect to dividend and voting rights.
Limited Liability – A C-Corporation also protects the personal assets of its stockholders by insulating them from the liabilities of the company in most cases, if corporate formalities are maintained.
Clear Statutory Scheme – Institutional investors also appreciate the clarity and guidance on rules and regulations related to corporate governance issues in a corporation which come with the incorporating in a jurisdiction with well recognized legal frameworks such as Delaware. Learn more about how the state of Delaware compares with other states with well recognized legal frameworks here.
Simplified Issuances of Equity Incentives to Employees, Consultants and Advisors – A C-Corporation can issue multiple classes of stock, which allow it to issue equity incentive awards (i.e., stock options and restricted stock awards) at a price per share to its employees, consultants and advisors that can be lower than the price of stock issued to investors. Typically, shares of common stock reserved for these equity awards is attributed a value lower than the preferred stock sold to investors, because those shares do not have the same liquidation preference or other preferential rights often required by investors. C-Corporations can also issue “incentive stock options” to its employees which provide certain tax advantages not available to other equity awards.
Qualified Small Business Stock Exemption – Unlike S-Corporations and LLCs, C-Corporations may be eligible to issue “qualified small business stock,” (“QSBS”) according to Section 1202 of the Internal Revenue Code as revised by the One Big Beautiful Bill Act (OBBA). This can provide a tremendous tax benefit if the requirements of the tax provisions are met. QSBS treatment generally allows (i) noncorporate founders and investors who acquired qualified small business stock prior to July 4, 2025 and held such stock for more than five (5) years to exclude 100% of the gain upon the sale of such shares up to the greater of $10 million or ten (10) times the basis of the stockholder’s initial investment, and (ii) noncorporate founders and investors who acquired qualified small business stock after July 4, 2025 to take advantage of a tiered-gain exclusion which allows such noncorporate founders and investors who held qualified small business stock for at least 3 years to exclude 50% of the gain upon the sale of their qualified small business stock at an effective US federal tax rate of 15.9%, 75% of the gain upon the sale of their qualified small business stock at an effective US federal tax rate of 7.95% if they held such stock for at least 4 years, and 100% of the gain upon the sale of their qualified small business stock if they held such stock for at least 5 years (more information about qualified small business stock and the tax implications of the OBBA here).
Cons:
Double Taxation – Double taxation is the primary drawback of C-Corporations. Any taxable income earned by a C-Corporation is taxed first at the entity level, and then, if stockholders are to receive distributions from the corporation through a dividend or otherwise, they will be separately taxed at the stockholder level.
Rigid Corporate Governance Requirements – In order to achieve the heightened clarity around corporate governance issues needed to attract institutional investors, C-Corporations are also required to follow strict rules, regulations and procedures that can be burdensome for early-stage startups without near-term financing options.
LIMITED LIABILITY COMPANY (LLC)
A Limited Liability Company (LLC) is an attractive alternative because it is subject to pass-through taxation. Unlike a C-corporation, an LLC is taxed like a partnership in the sense that profits and losses of the entity are passed through to the members of an LLC. Each member of an LLC is liable for tax on its pro rata share of the income earned by the entity. The LLC does not separately pay income taxes. An LLC also provides more flexibility to alter the rights, preferences and privileges granted to the members of an LLC. However, an LLC also has a number of weaknesses, including unattractiveness to some institutional investors, difficulty issuing equity broadly, potential issues relating to convertible debt financings and the inability to conduct an initial public offering.
Who should consider an LLC?
An LLC is not optimal for founders who anticipate raising money from traditional venture capital funds and other institutional investors in the near future – primarily because the tax treatment of LLCs is deferred by such investors. However, an LLC may be ideal for founders who intend to raise funds through friends, family and other individual investors. Founders who may be considering an S-Corporation may also find that an LLC is a more practical alternative because it is not subject to the strict limitations required to maintain status as an S-Corporation as discussed in detail below.
Pros:
Pass-Through Taxation – Similar to a partnership, the profits and losses of an LLC are not subject to tax at the entity level and are allocated to and payable directly by each of the members on a pro rata basis.
Flexible Structure – The LLC’s primary advantage over a C-Corporation and an S-Corporation is the additional flexibility provided by an LLC’s primary governing document, referred to as either an operating agreement or limited liability company agreement. Unlike the strict requirements for rigid corporate governance in a corporation, an LLC’s operating agreement can be tailored to the needs of the founders with less administrative hurdles while also allowing for features such as profits interests, multiple share classes and unique liquidation and distribution structures.
Limited Liability to its Owners – Similar to stockholders in a corporation, members of an are generally protected from the liabilities of an LLC.
Conversion to Corporation – Depending on the state in which the LLC was formed, an LLC can also often be easily converted into a corporation.
Cons:
Often Not Suitable for Venture Capital Financing – Although an LLC may establish and subsequently issue multiple classes of units, it is generally not a suitable legal structure for raising venture capital funds due to certain tax restrictions applicable to the tax-exempt and non-U.S. investors of such funds.
Qualified Small Business Stock Exemption is Not Available — Unlike the C-Corporation, an LLC is not eligible to issue qualified small business stock to its members, which may subject members of an LLC to less favorable tax treatment in the event of a sale of the entity.
Equity Awards More Cumbersome – Unlike a corporation in which equity awards can be easily granted to service providers, equity awards are much more difficult to award in an LLC. Rather than equity awards, service providers to an LLC are granted profits interests which entitle holders to a certain percentage of the LLC’s profits and require different tax reporting and payment obligations that may be unfamiliar and burdensome to many service providers.
Complexity – Increased flexibility in an LLC’s operating agreement also invites additional complexity and less standard terms than the organizational documents of a corporation. This complexity can also add additional expense to implement.
Inability to Conduct a Public Offering – Unlike a corporation, an LLC is not eligible to conduct an initial public offering and in general would convert to a corporation prior to an initial public offering under the Securities and Exchange Act of 1934.
Potential Issues Related to Convertible Debt Financing – Corporations also commonly issue convertible promissory notes as a form of financing. However, unlike a corporation, issuing such notes is substantially more complex in an LLC. The use of debt can also cause unexpected tax consequences for members of an LLC when such debt is paid off or converted to equity or the LLC converts to a corporation.
S-CORPORATION
Similar to an LLC, an S-Corporation enjoys the benefits of pass-through taxation, however, in order to become an S-Corporation, the entity must make an S-election by filing IRS Form 2553. In order to maintain status as a valid S-Corporation, the entity may not (i) issue more than one class of stock, (ii) have more than 100 stockholders, (iii) issue stock to partnerships, corporations and certain trusts and non-exempt organizations, or (iv) issue stock to non-U.S. citizens or residents. If at any time the S-Corporation fails to meet any of these strict requirements, the S-Corporation shall automatically revert to a C-Corporation and be subject to potential double taxation. Also similar to an LLC, an S-Corporation is not eligible to issue qualified small business stock to its stockholders, so stockholders give up the very significant benefits of QSBS treatment. For these reasons, an S-Corporation may be a better fit for closely held businesses which rely on individual investors and do not expect to issue substantial equity awards to its employees and consultants.
SO WHICH ENTITY TYPE SHOULD YOU CHOOSE?
Founders who anticipate receiving outside capital from venture capital funds or other institutional investors in the near future should strongly consider forming a C-Corporation. In general these categories of investors do not want pass-through tax treatment and do want to take advantage of QSBS treatment – two key benefits of using a C-Corporation.
Founders who do not anticipate receiving outside capital from institutional investors should consider an LLC or S-Corporation to enjoy the benefits of pass-through taxation. LLCs tend to be the more common structure because of their flexible organizational documents and ability to access a larger pool of investors due to their ability to issue multiple classes of units with various rights, preferences and privileges. However, founders who plan to run a closely held business which issues only a single class of stock to individual U.S. investors, may also consider a S-Corporation since it invites less complexity in its organizational documents, issuances of equity awards and convertible note financings.
Choosing the ideal entity to properly match the goals of its founders is a nuanced decision that depends on a founder’s near-term plans for funding and long-term vision. While these general guidelines are aimed to frame your approach to selecting the right entity for your next venture, there are a number of additional factors to be considered when developing the long-term strategy for your new entity. For example, forming an LLC at the outset to enjoy the benefits of pass-through taxation for a number of years prior to converting to a C-Corporation before raising institutional capital may be a good approach for certain founders.
Given the many variables involved, we recommend consulting with legal counsel to ensure your entity choice aligns with your long-term business strategy and growth plans.