I am frequently asked by founders of new businesses who want a pass through company for tax purposes whether they should organize their new company as an S corporation or a limited liability company. It depends on the circumstances, but if the founders anticipate having a company which will grow rapidly, want to grant equity compensation to many new hires, and ultimately may either go public or be sold in an M&A transaction, I recommend an S corporation (assuming the entity qualifies to make an S corporation election), for the following reasons:
- S corporations can engage in tax free reorganizations, such as tax free stock swaps; in contrast, limited liability company owners have to pay tax on stock received in such transactions;
- S corporations can grant traditional types of employee equity, like stock options, more easily; and
- S corporations can more easily convert to C corporations in the event of a venture financing or public offering.
That is not to say that a limited liability company may not be the right choice of entity in certain circumstances, but frequently S corporations are a better choice.