llc-vs-s-corp

LLC vs. S-Corp

An LLC is a limited liability company. This type of company offers a corporation’s limited liability protection but with a partnership’s tax benefits. An S-corp is a “pass-through” entity, meaning the business’s income and losses are passed to the owners and taxed at their income tax rate.

Why does the difference between LLC and S-corporation matter?

When you’re starting a business, one of the first decisions you have to make is what type of entity to form.

There are a lot of choices, but two of the most popular are the limited liability company (LLC) and the S-corporation. So, what’s the difference?

Both an LLC and an S-Corp offer liability protection for their owners, meaning that if your business is sued, your assets are safe.

An LLC is less formal than an S-Corp and is easier to set up, but an S-Corp offers more tax benefits.

So, which is right for you?

That depends on your business and your goals. In this article, we’ll break down the pros and cons of each entity type so you can make the best decision for your business.

What Is an LLC?

An LLC is a limited liability company.

This type of company offers the limited liability protection of a corporation but with the tax benefits of a partnership.

This means that the company is a separate legal entity, and the owners (called members) are not personally liable for the debts and liabilities of the company.

Membership in an LLC is not restricted by sex, race, or religion, and there are no limits on who can own an LLC.

The company can have unlimited members, and members can come and go as they please.

This makes LLCs a good choice for businesses that are just starting because they are easy to set up and maintain.

Benefits and Drawbacks of Forming an LLC

The most significant benefit of an LLC is that it’s easy to set up and manage.

Far fewer regulations and paperwork are involved, making it a very attractive option for small business owners.

Another significant benefit is that members of an LLC are protected from personal liability.

So, your assets are safe if your business runs into money troubles.

This is not the case with an S-Corp, which can be a major deterrent for some business owners.

The main drawback of an LLC is that it’s not as tax-efficient as an S-Corp. Because of how LLCs are taxed, some business owners end up paying more in taxes than they would if they had formed an S-Corp.

What Is an S-Corp?

An S-corp is a “pass-through” entity, which means that the business’s income and losses are passed through to the owners and taxed at their personal income tax rate.

This can help reduce individual tax rates since the corporation itself doesn’t pay taxes.

An S-corp has shareholders—real people who own shares in the company—which makes it more suited to larger companies with multiple owners.

Benefits and Drawbacks of Forming an S-Corp

An S-Corp’s most significant benefit is its limited liability protection.

This means that you’re not personally liable for any debts or legal judgments against your business, which can be especially helpful if you have personal assets to protect.

S-Corps may also offer tax advantages since they are taxed differently than LLCs.

On the downside, the process of forming an S-Corp can be time-consuming and costly.

Plus, it requires more ongoing paperwork and compliance measures than forming an LLC.

For instance, S-Corps must file corporate tax returns yearly and maintain corporate records like meeting minutes and bylaws.

Additionally, there are limits on shareholders and stock classifications, so if your business grows quickly or has many investors, an S-Corp might not be the best fit.

Critical Differences Between LLCs & S-Corps

As you can see, the biggest differences between LLCs and S-Corps are the tax structure, ownership, and filing requirements.

An LLC offers pass-through taxation, meaning that company profits or losses are passed through to the owners, who report their share of the profits or losses on their taxes.

An S-Corp has similar pass-through taxation but also offers limited liability protection and restrictions on owner participation.

With an LLC, the owners have the flexibility to choose how they want the business to be taxed.

With an S-Corp, certain requirements must be met to take advantage of certain tax benefits.

In addition, LLCs have a single level of taxation, while S-Corps have two levels of taxation (corporate and individual).

With an LLC, all profits are passed through as personal income, whereas with an S-Corp, profits can remain as corporate income.

This difference can result in significant tax savings for businesses depending on their taxable income levels.

Another major difference between an LLC and an S-corp is that an S-corp has shareholders—real people who own shares in the company—which makes it more suited to larger companies with multiple owners.

A single-member LLC doesn’t have shareholders, but if you have more than one owner, you would need to convert your LLC into an S-corp.

Finally, LLCs require fewer formalities when filing documents, making them more straightforward for owners who don’t need a complicated structure.

Key Takeaways

  • In the end, both LLCs and S-Corps can offer liability protection and tax benefits—depending on your business needs.
  • If you’re unsure which structure is right for you, you should speak with an accountant or attorney who can help you determine which entity makes the most sense for your business.

Connected Financial Concepts

Circle of Competence

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The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

What is a Moat

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Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Buffet Indicator

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The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Venture Capital

venture-capital
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.

Foreign Direct Investment

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Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country. 

Micro-Investing

micro-investing
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.

Meme Investing

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Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.

Retail Investing

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Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.

Accredited Investor

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Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.

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Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.

Profit vs. Cash Flow

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Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.

Double-Entry

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Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.

Balance Sheet

balance-sheet
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).

Income Statement

income-statement
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Cash Flow Statement

cash-flow-statement
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.

Capital Structure

capital-structure
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).

Capital Expenditure

capital-expenditure
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.

Financial Statements

financial-statements
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.

Financial Modeling

financial-modeling
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.

Business Valuation

valuation
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.

Financial Ratio

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WACC

weighted-average-cost-of-capital
The Weighted Average Cost of Capital can also be defined as the cost of capital. That’s a rate – net of the weight of the equity and debt the company holds – that assesses how much it cost to that firm to get capital in the form of equity, debt or both. 

Financial Option

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A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.

Profitability Framework

profitability
A profitability framework helps you assess the profitability of any company within a few minutes. It starts by looking at two simple variables (revenues and costs) and it drills down from there. This helps us identify in which part of the organization there is a profitability issue and strategize from there.

Triple Bottom Line

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The Triple Bottom Line (TBL) is a theory that seeks to gauge the level of corporate social responsibility in business. Instead of a single bottom line associated with profit, the TBL theory argues that there should be two more: people, and the planet. By balancing people, planet, and profit, it’s possible to build a more sustainable business model and a circular firm.

Behavioral Finance

behavioral-finance
Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.

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