We always address the issue of which form of entity is best for your startup. This is never a “one size fits all” answer. If you are advised that one form of entity is right for all new businesses, your advisor does not understand all of the relevant issues. As an aside, there seems to be an abundance of advisors that are pushing the “LLC that elects to be treated as a corporation that then elects Subchapter S status” routine but that is an issue for another post. Suffice it to say that the determination is based on the type of company you will operate, the place that you form and operate it, the anticipated path for invested capital and a host of other issues.
Not every startup can afford to have those issues evaluated up front. So, this post is to those who are not in a position to pay for advice–just form an LLC and do not go through the process of treating it as an S corporation. Now, a limited liability company may not end up being the correct entity for your business, or your later investors, or for you, as the initial owner, but I suggest that you err on the side of using it for reasons that I will briefly outline.
Firstly, the LLC is tax efficient and, in most cases, offers similar liability protection to its owners as a corporation. Secondly, it does not require the filing of an election, as in the case of the S corporation, in order to have this tax efficiency. In the case of the LLC, it exists by default.
The LLC will offer incredible flexibility because you can add founders or investors without respect to who they are or where they are and you can create whatever classes of interest that the market requires without destroying the tax efficiency (which is not the case with an S corporation or an LLC that elects to be treated as an S corporation). Multiple classes, different economic rights, dividends, liquidation preferences–no problem.
The final simple answer is that it is quite easy, in most cases, to change from an LLC to a corporation and, unlike in the case of changing from a corporation to an LLC, this generally does not create a tax liability associated with the switch. Just in the last several months, we have converted LLCs into corporations for three separate entities that needed to convert in connection with a subsequent change in circumstances. The state filing fees are minimal and the legal issues and time are not significant.
Therefore, the LLC gives the most flexibility, tax efficiency and the ability to easily change later if you find you made a mistake (or the circumstances change and dictate a different form of business). Starting companies is often done under imperfect circumstances such as when there is not sufficient ability to get professional advice. In these circumstances, there are judgement calls that need to be made. I would form an LLC. Depending on what state you use, there could be other issues to consider. However, in the states where I have had first hand experience, the answer is the same. Best of luck with your new startup.