LLC vs Corporation: A Lean Perspective

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One of the first decisions I had to make as co-founder of Retrium was how to legally form my business (I chose an LLC). You can find many articles online comparing and contrasting LLCs with Corporations, and as a founder, it’s well worth your time to understand the implications of each option. In a nutshell, an LLC has two key features that make it very attractive. First, as a pass-through tax entity, it avoids double taxation. Second, it provides personal liability protection for the owners of the business. (Note: the advantages and disadvantages of LLCs vs. other business types is a very complex subject — so please do your own research.)

Despite these advantages, it’s rare to find startups that have formed as an LLC. In fact, if you search on Google for “Startup LLC or Corporation“, the vast majority of the articles you will find argue that tech startups should be structured as a corporation. In most cases, I disagree. And it’s because I’m a lean startup aficionado.

Why Most Startups Should Form as an LLC

Like most startups, I’m going to assume that yours has limited cash and therefore a short runway. The number one risk factor for a startup in this situation is your ability (or, rather, inability) to find your first customer. If you can’t find that elusive first customer, you’re done. Out of Business. Kaput.

As a result, you should have a laser focus on finding someone to pay you for whatever it is that you are building. That means saying ‘no’ to any expenses that don’t directly support this goal. Which also means saying ‘no’ to forming as a corporation. Corporations are like bad boyfriends or girlfriends. They are expensive. Expensive at the beginning (formation costs are high) and expensive to keep (annual filings are complex and costly). LLCs are the opposite. Formation costs are minimal and they have very few ongoing legal requirements.

Delay Expensive Decisions Until You Have More Information

By choosing to form as a corporation early on, you’re basically saying: “The best use of these few thousand dollars is to form a complex legal entity.” Not to build your product, not to advertise, not to do market research. To form a legal entity. Are you sure that’s the case?

Here’s an alternative. Form as a low cost LLC. You can always switch to a corporation if you need to (for example, if you are closing in on a funding round and the investor requires it). Yes, there are associated switching costs, but I recommend it anyway. Here’s why it’s a good, lean strategy:

  1. It keeps your costs low while your runway is short
  2. It tells investors you know how to spend money wisely
  3. And most importantly, it extends your runway by delaying your decision to spend significant money on business formation until it is required

The Key Takeaway: Be Lean

The key takeaway here is to apply lean startup to as many decisions you are making as a founder as possible. Lean says we should follow the “build-measure-learn” feedback loop. In other words, we should build a small bit of product, test it in the marketplace, learn what works and what doesn’t, then start all over again. Applied to the choice of LLC vs Corporation, here’s what build-measure-learn looks like:

  • Build – form as a low cost, inexpensive LLC (that’s your small bit of “product”)
  • Measure – see if it’s working for you (can you find funding as an LLC? is it preventing you from giving equity to employees?)
  • Learn – if the LLC is preventing you from achieving something critical to your business, switch to a corporation; if not, don’t

Then, rinse and repeat.

In fact, the principle of build-measure-learn can be applied to almost every decision you have to make as a startup founder. Keep that in mind as you continue on your entrepreneurial journey.

 

2 thoughts on “LLC vs Corporation: A Lean Perspective

  • April 15, 2015 at 1:03 am
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    yeah I think the main reason you don’t see LLC startups is the need for equity shares/stock plans as a crucial component of compensation for attracting and retaining talent. Also 83b elections help avoid the capital gain taxes.
    Of course most startups don’t expect to be profitable in the near term so double taxation isn’t as much of an issue either.

    Still, LLCs are great and much better than sole/p’ships given the corporate shield.

    Reply
    • April 17, 2015 at 3:41 pm
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      Agreed. While it’s possible to issue % interest to new employees as an LLC, it’s certainly much more difficult than as a corporation. But that’s exactly the point of my blog post. If there’s a need to be a corporation, be a corporation. It’s just that, far too often and especially for bootstrapped startups w/o employees, founders choose to be a corporation without truly considering the LLC alternative.

      Reply

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