Disclaimer: This blog is intended to provide helpful information, not legal advice
Choosing the right legal structure is key to the success of any business, whether you’re starting a business from scratch or starting a franchise. Some of the various formations include an LLC, C-Corporation, or S-Corporation.
While a franchise can operate under all of these business structures, you should note that the franchise agreement will typically outline which one to choose. However, if it’s up to you to decide, then it’s important to seek legal counsel that specializes in franchising and is local to your area since laws can vary from state to state.
Franchise Operating As An LLC
What is An LLC?
Limited Liability Corporations (LLCs) are among the easiest of business structure’s to employ. A couple of important characteristics to know about an LLC are that it:
- Keeps business assets separate from personal assets
- Keeps the business from being taxed at the corporate level
- Doesn’t have the option for investors to obtain shares of the company
It’s advisable to have professional guidance while setting up the LLC since the specific requirements for operating an LLC can vary by jurisdiction.
3 Advantages to an LLC Structure
#1 – Less Bureaucracy
Setting your franchise up as an LLC offers operating simplicity, with less paperwork and requirements for compliance. While an LLC may require some filings, it won’t be to the extent of a corporation. With a corporation, a business owner is legally required to keep rigorous financial records and submit regular public filings.
#2 – Protects Personal Assets
A key advantage to choosing an LLC is that it shields the members’ personal assets against debts, losses, and court rulings against the business. Because an LLC keeps business assets and personal assets separate, a lawsuit against your business won’t threaten your family’s personal finances, property, etc.
#3 – Offers Tax Benefits
No one loves tax season, but an LLC structure does provide a tax benefit to businesses. An LLC allows a business owner to be treated as a pass-through entity for tax purposes. This means that the LLC isn’t subject to an income tax, rather, the net income is taxed at the individual level. This avoids a double taxation situation where both the entity (LLC) and individuals are taxed.
The Disadvantages to Making a Franchise an LLC
There are a few potential drawbacks to operating an LLC, but most of them are not necessarily a problem if you’re buying a franchise business. These are:
- Still have liabilities – It’s true that an LLC business structure limits the owner’s personal liability. However, a franchisee will still have a certain level of personal liability to the franchisor, which is outlined in the franchise agreement. Keep in mind this is not a unique disadvantage to an LLC since the same drawback applies if you structure your business as a corporation.
- Difficult to obtain investments – Investors might be more hesitant to help finance an LLC since they aren’t able to receive shares of the company. However, the franchisor might have financing options available that make this less of an issue.
- On your own to figure things out – Because there are less regulations around how to set up and operate an LLC, then it can be a daunting process for a first-time business owner. However, the franchising system helps offset this since the franchise agreement often gives detailed instructions about how to set up and operate the business.
Franchise Operating As A C-Corporation
What is a C-Corporation?
A C-Corporation, or C-Corp, is the most common type of business structure in the U.S. With a C-Corp, the business is established as a separate legal entity from its owners. A few notable characteristics include:
- Allows corporation to sell shares of stock in order to raise capital
- Provides limited liability to its shareholders
- Some business expenses are tax-deductible
The term “C Corporation” is derived from the fact that this type of corporation is taxed under Subchapter C of the Internal Revenue Code.
3 Advantages to a C-Corporation Structure
#1 – Unlimited Growth Potential
There aren’t any restrictions to the amount of shareholders a C-Corp can have, which means that the number of investors can be unlimited – as well as their contributions. This allows the business to pursue ambitious growth plans.
#2 – Protects Personal Assets
Since shareholders in a C-Corp have limited liability, then their personal assets are generally protected from business debts and other liabilities. This makes the C-Corp business structure an attractive option for investors.
#3 – Attracts Partners
Not only does the limited liability aspect attract investors, but the tax-deductible business expenses that are possible with a C-Corp also makes it an attractive option for valuable business partners.
The Disadvantages of a C-Corporation
Where an LLC offers advantages in the way of less bureaucracy and tax benefits, the C-Corp business structure has drawbacks in these areas. Not only is a C-Corp subject to more complex requirements both with the set-up and ongoing operations, but it also runs into the issue of ‘double’ taxation. This is where the revenue is taxed both at the company level and again when the dividends are awarded to its shareholders.
Franchise Operating As A S-Corporation
What is an S-Corporation?
Many people like to think of S-Corporations as a ‘Lite’ version of C-Corporations. The similarities include:
- Limited liability protection provided to the owners
- Allows shareholders, directors, and officers
While the structure of both C-Corporations and S-Corporations are similar, a couple of notable differences include:
- S-Corporations operate as a pass-through tax entity (in the same way as an LLC)
- S-Corporations are capped at 100 shareholders (hence, the ‘Lite’ version of a C-Corp)
2 Advantages to a S-Corporation Structure
#1 – Protects Personal Assets
Just like the LLC and C-Corporation, a structure that offers limited liability to protect the owners’ personal assets from debts and other liabilities is a huge benefit to the S-Corporation.
#2 – Offers Tax Benefits
In the same way an LLC is set-up to avoid the issue of ‘double-taxation’, an S-Corporation’s designation as a pass-through entity allows it to avoid being taxed at the corporate level and again on the shareholders’ personal income taxes. This is an advantage that sets the S-Corporation apart from the C-Corporation.
The Disadvantages of a S-Corporation
In contrast to the C-Corp, a key drawback that comes with an S-Corporation is the cap of 100 shareholders. This limit restricts the ability to attract a large number of investors or go public. This makes an S-Corporation an unlikely choice for businesses that have extensive growth plans.
Don’t Go It Alone – FranNet Can Help
While these three business structures are the most commonly used formations for new businesses and franchises, it’s still important to seek professional guidance before making a decision. At FranNet, we have the resources available to help you navigate the process of buying a franchise from start to finish. Our expert franchise consultants will evaluate your goals and abilities to match you with the right franchise opportunity. Better yet, our services come at no cost to you. Schedule your free consultation today to get started!