Investors prefer corporations for a variety of reasons that we’ll cover in this article. If you’re seeking an investment in your company now or in the near future, I’d seriously consider the corporation entity type.
Let’s jump right in.
Firstly, investors prefer corporations because of taxes. “But what about double taxation?” You ask. That’s a concern in only a few scenarios.
Double taxation is the idea that the IRS takes a chunk of your income when it is earned by the corporation and then again when you’re paid by that corporation. However, this is largely a myth in small business because you can deduct you w-2 wages from corporate earnings. Therefore, the IRS only takes a portion of the corporate earnings minus your salary. Most small business owners pay themselves everything they make.
In fact, most small businesses lose money the first few years, especially ones driven by investment. You generally don’t classify money received from an investor as income. Therefore, as you’re using that money to pay expenses, your company will show a net loss. If you’re losing money, you’re not paying taxes.
We’ll get to the exceptions in a second.
Typically, an investor gives you a certain amount of money with the hopes they’ll be able to sell their stake in a few years for a profit. In this scenario, the investors only sees a tax when they sell. However, that’s only true if the entity is a corporation!
If your business is an LLC, the profits and losses carry to the owners, regardless of if they’re getting paid. Therefore, an investor could see a tax bill without getting a penny from the company. This is the main reason investors prefer corporations.
Secondly, investors prefer the clean nature of stocks. A stock is a representation of ownership in a company. Stock is easy. A company has a certain number they can give out. To find out how much of the company you own, you taken your shares divided by the total given out. You also know the minimum you could own by dividing your shares by the total authorized shares. Typically, the authorized number is available as public record.
You can buy and sell stocks just like any personal property unless the company restricts this activity in any way. Fortunately, there are centuries worth of rules protecting investors in a corporation. There are quite a bit fewer rules protecting owners in an LLC. That’s because LLCs are meant to be more flexible. Consequently, that means they’re more complicated. In both corporations and LLCs, you use contract law to place limits on how, when, where, and for how much you can transfer ownership.
Contrary to popular belief, the limited liability protection is virtually the same between LLCs and corporations.
These were the main two reasons that generally investors prefer corporations over LLCs. However, with every rule there are exceptions.
If your investor is looking for regular returns in the form of dividends, royalties, or similar structure, an LLC would make more sense from a tax perspective.
One of the biggest exceptions is for real estate. If your business is real estate investing, LLCs are almost always the way to go. The tax benefits are too good to pass up.
Finally, if your investor is working in the business, LLCs are again one of the best options. In an LLC, owners can work outside employment protection laws. This is beneficial because you don’t have to do time keeping, pay hourly, or withhold taxes. Keeping your administrative burden down is worth quite a bit. Technically, they’re also not investors if they work substantially in the business.
There you have it. These are the reasons I see why investors prefer corporations over LLCs.