When learning about the different types of business structures, it’s important to know your business model before committing to a structure. If you need large, institutional investments, then your structure may be different from a typical SaaS (software-as-a-service) business model.
Here, you will discover what limited liability companies (LLCs) are and how they differ from corporations so you can compare the two structures and choose which one will fit you.
What is an LLC?
An LLC is a structure where business owners are not held liable for all liabilities. It is a mix between a company and a partnership.
In partnerships, the income generated can be passed onto the owners. On paper, this income is the owners’ income. These businesses don’t pay corporate tax because the income is technically their personal income. This flow-through model exists in LLCs.
The limited liability of LLCs is a feature of corporations, in which the shareholders may profit but aren’t liable for the corporation’s debts.
Laws Surrounding LLCs
In the United States, LLC laws are different in each state, so you want to check with your state before associating yourself with an LLC. There are also federal laws that are enforced in all states.
If you are an LLC, you must file a Form 1120. Deductions such as income and expenditures are included in this form. You must also file a Schedule K-1, which covers your profit and loss, along with a Form 1140.
Since LLC owners are self-employers on paper, they must pay self-employment taxes, which has a rate of 15.3%. As with most self-employers, LLC owners must estimate the yearly taxes and pay quarterly payments on that.
Some services have different rules surrounding them. If your LLC offers services for licensed professionals, then you have to be recognized as a professional LLC (PLLC). PLLCs can be sued for malpractice, and all members are liable. Due to this, it’s common for PLLCs to have insurance.
Setting Up an LLC
There are legal procedures to follow when setting up a limited liability company.
First, you may have to announce your intentions publicly. You can do this by contacting your local newspaper and having something published. Contact your local LLC filing office to send your affidavit of publication to them.
When naming your LLC, you must include “Limited Liability Company” or “LLC” in your name. The name of your company can’t match the name of another registered LLC in your state. There are certain restricted words, such as “Bank” or “City,” so check with your state to view the laws on forbidden words.
When your company receives legal paperwork, a registered agent is required to handle those documents. They must be registered to work in your state and have an address within that state.
Before finalizing your LLC, check your state and local laws to see which permits and licenses are required. This process may have costs, so it’s best to know this information beforehand.
Articles of Organization are legal documents that finalize your company name. File these with your state to register your LLC. Although there is a filing fee, you can edit the documents online for free.
When it comes to hiring employees, the laws and regulation vary by state. All states require you to obtain an employer identification number, which you can receive by contacting the IRS.
Advantages/Disadvantages
Your business may either flourish or fail when forming a limited liability company, so it’s good to know the advantages and disadvantages before you begin. Your situation will determine if this business structure is for you.
Advantages
As an owner, you aren’t held responsible for any debt or lawsuits. Since this reduces the risk associated with business, this is a major advantage. All lawsuits filed against your LLC will only be put to your LLC’s assets, such as the company bank account. If your company is accused of unfair business practices, then only your LLC’s assets will be at risk.
When operating an LLC, you qualify for tax deductions. The LLC’s profits and losses are merged with your personal income, so the rates are lower. If you, and the LLC owner, report the LLC’s profits as $500,000, that would be filed under your personal returns.
An LLC doesn't come with the same regulations as a corporation. There are fewer burdens and bureaucracy when operating this kind of company.
With LLCs, you have different taxation options. If you want to be taxed as an S corporation, the profits will be taxed at personal tax rates. If you want to be taxed as a C corporation, you’ll pay taxes at a corporate tax rate of 21%. You can choose the tax model that you want. Both of these options save you money.
Disadvantages
For your LLC to be legally recognized, you must pay the paperwork and regulation required. The fees and licenses can cost you hundreds of dollars, so initial investments are required. Although an LLC will protect your personal assets, the paperwork required can be burdensome.
With an LLC, investors can’t own stock. Unless your business doesn’t require investors, you will have a hard time finding anybody willing to invest. If you can’t issue stock, then outside investors won’t be interested. You may offer part-ownership of your company, but this is less desirable than stock. Owning stock is an easy process, while LLC ownership interests are not.
Corporation vs. LLC
Your vision for your business will lean you towards either an LLC or a corporation. If you plan to have massive growth in the number of investors and employees, you will eventually want to transition to a corporation.
However, small-startup owners should stick with an LLC because there are lower risks and fewer burdens. Managing your business will be easier, and you won’t be putting your personal assets at risk.
Why an LLC?
If you don’t plan on raising venture capital and don’t expect early profits, then an LLC is the best option. If your startup needs extra revenue early on, you will be able to take advantage of LLCs’ tax savings. If you don’t require institutional investments, your startup will be better off forming as a limited liability company.
Small-business owners gain personal asset protection with an LLC, which is great for early startups. Many startups don’t have the capital to survive a lawsuit, so having that protection reduces the risk associated with corporations.
With little burdensome regulation, you can operate your business professionally by having an LLC. Early-stage startup owners who plan on having a minimal management structure will benefit from choosing an LLC.
Why a Corporation?
If you have a large business with an intricate management structure, then making it a corporation will be a sensible transition. You will be able to comply with the regulations and paperwork without the burden of not keeping up.
If your business has a growing number of investors, you will start to experience tension when they request partial ownership. Corporations sell stock, and stock shows ownership within a company. The bigger your business becomes, the more you will run into large investors who will push your business into a corporate structure.
Health insurance is tax-deductible in a corporation. If you want to start offering more benefits to employees, switching to a corporation will save you money. Unlike an LLC, a corporation can deduct the cost of medical expenses. The larger your business grows, the more demand you will get to provide these fringe benefits.
To stay competitive as a large business, you have to offer employees benefits. Stock and health insurance are attractive bonuses that’ll bring in employees. When you are a large business, you will fall behind if you don’t provide strong incentives.
Should Your SaaS Startup be an LLC?
SaaS startups provide their customers with a service they develop. The software they create is available online, so the forms of distribution are different from those of traditional companies.
How does a SaaS Business Model Differ from a Traditional One?
With SaaS startups, your business model is typically a subscription-based service delivered through the cloud. SaaS startups require a different approach since their software installation doesn’t require physical copies.
Microsoft offers Office 365 at a paid subscription fee for a certain amount of users. This example is a SaaS model because the service is delivered through the cloud.
Implementing cloud services is much faster than installing software on any other system. With traditional software implementation, you could spend thousands of dollars planning and executing at the implementation stage. With SaaS startups, you’ll have less to worry about when you’re at the implementation stage.
You also have more employment opportunities, since working on the cloud can be done remotely. Whenever one of your team members needs to access the software, they can effortlessly get access.
A SaaS startup costs less due to the subscription-model licensing. Everything is done at an instant without the cost of hiring and training an IT team.
As your SaaS business grows, you can easily manage the increased growth because the cloud makes scaling straightforward. The cloud makes management and planning scalability much easier, as well.
SaaS startups make support and maintenance cheaper and quicker, too, because remote workers can do all maintenance and upgrades in an instant. Traditional software maintenance required trained technicians to physically work on your desktop.
Why Your SaaS Startup Should be an LLC
SaaS startups are usually very small at the beginning and aren’t traditionally managed. This means board meetings and the bureaucracy of a corporation would weigh you down.
LLCs are simple, and they don’t have to pay corporate tax. When you are a low-revenue company, the tax model of a limited liability company appears relieving. You get to keep more revenue that you can invest back into your business. SaaS startups would greatly benefit from this.
Many SaaS startup companies may plan on having a very small number of investors. LLCs don’t have stock to offer, so this makes investing difficult. Corporations are mainly created for investment opportunities, so you may prefer forming a SaaS startup as an LLC.
Overall, SaaS startup businesses should form an LLC since they won’t be bringing in much revenue and aren’t going to need big investors. The burden of dealing with the regulations of a corporation would make you worse off.
With an LLC, you are taxed less and have the freedom over how your business is structured and how you distribute your data online.
Conclusion
When deciding your business structure, there are a lot of factors to consider. The corporations’ tax laws and regulations seem to benefit big companies instead of startups.
When forming an LLC, you have the professionalism of a corporation while keeping the freedom of a partnership. For SaaS startups, you can greatly benefit from the low tax rates LLCs offer.