When you’re starting a small business, you’ll no doubt ponder what business structure is right for you. Or maybe you’ve been in business for years, and now you’re wondering if your current structure provides the most advantages.
You may have heard in recent years that for small businesses, corporations are a thing of the past, dethroned by the nimbler, less cumbersome Limited Liability Company (LLC).
Well, maybe si, maybe no.
Whether you already own a business or are just getting ready to start one, consider these five reasons for why the corporation may be the right structure for your business.
Both LLCs and corporations bring in profit, but only the default tax structure of a corporation allow those profits to be reinvested into the company without paying additional tax. As a single-member LLC owner, all of the profits pass through to you, which looks great in your bank account but may hurt you come tax time.
If you’re incorporated, however, you can pay yourself a reasonable salary, pay the corporate tax on your net profits, and then choose to dole out the remainder as dividends or reinvest it in research, development, or future growth. If you take the dividends, you’ll have to pay tax again on that money. But as long as the money stays in the corporation, no additional tax needs to be paid.
Reinvestment, or retained capital, is a powerful corporate tool, especially for small business owners. The great white whale that swallows most small businesses is debt. By reinvesting profits into your company, you can avoid future debt and keep more money in-house to fuel growth. Meanwhile, retained capital sends a strong message to outside investors that you are an incisive, dedicated owner.
2. Legal Precedent
While LLCs offer a number of advantages to their members, one significant drawback is a lack of legal precedent. In the United States, Wyoming was the first state to legalize the LLC business structure … in 1977. The reality, then, is that American courts have ruled on cases involving LLCs for less than four decades.
LLCs have a longer standing history outside the US, but even so, the most widely accepted “first LLC” in history occurred in Germany in 1892, which makes the structure barely over 100 years old.
Compare this to the corporation structure. In western culture, the basic concept of a separate corporate entity endowed with legal rights stretches back to the Roman Empire (although there is little resemblance between modern and Roman corporations).
With hundreds and hundreds of years of history, corporations have a distinct advantage. When a corporation goes to court, centuries of legal precedent gives shareholders a clear idea of exactly how judges will most likely decide any given case.
LLCs, unable to draw upon a similar level of precedent, are in a much more precarious position.
Remember how many Microsoft employees became overnight millionaires during the 1990s? If Bill Gates had been a sole proprietor or LLC, those employees would still be driving Pintos instead of Audis.