Choosing the right legal entity is one of the most important decisions you’ll make for your startup. Your entity type determines how you are taxed, what kind of liability protection you have, how you can raise capital, and even what your long-term exit options look like. That said, it can be tough to know which structure aligns best with your goals.

In this article, we’ll break down the differences between the most common entity types, outline the pros and cons of each, and provide guidance on which option might be right for you based on your growth plans, funding strategy, and operational needs. Whether you’re bootstrapping a lifestyle business or planning to raise venture capital, understanding the tradeoffs between structures will help you set your startup up for long-term success. 

Key Factors to Consider When Selecting Your Entity Type 

There are many considerations when it comes to selecting a legal entity type. Below are some key items to think through when deciding to incorporate your startup: 

• Tax Treatment: Different entities are taxed in very different ways. LLCs taxed as partnerships and S-Corps are typically “pass-through” entities, meaning profits are taxed at the individual level, avoiding double taxation. C-Corps are subject to corporate tax, and then dividends are taxed again at the shareholder level. The best option depends on your profit expectations, reinvestment plans, and ownership structure. 

• Liability Protection: Your entity type affects whether your personal assets are shielded from business liabilities. LLCs, S-Corps, and C-Corps all offer limited liability protection, meaning your personal finances are typically protected if the business is sued or takes on debt. In contrast, sole proprietorships and general partnerships offer no such protection. For startups, limiting liability is usually a top priority, and should be discussed with qualified legal counsel prior to selecting an entity type. 

• Fundraising goals: If you plan to raise capital from venture capital firms or institutional investors, your entity type matters. Most VCs require a Delaware C-Corp for its familiarity, flexibility, and stock option structuring. LLCs and S-Corps generally can’t accommodate institutional ownership due to tax and legal limitations. If fundraising is a major goal, plan accordingly from the start. 

• Operational Complexity and Cost: Some entities are easier and more economical to maintain than others. LLCs and sole proprietorships typically have minimal paperwork and annual requirements, making them attractive for lean startups. S-Corps and C-Corps involve more administrative overhead, compliance obligations, and formalities (such as board meetings and stock ledgers). 

• Future Exit Plans Your long-term plans—like selling the company or going public—should inform your choice of entity. C-Corps are the most exit-friendly, particularly for acquisitions or IPOs, due to their standardized structure and ability to issue preferred stock. Other entities may complicate or limit these opportunities, potentially requiring a conversion down the line. Planning for the future can save time and money later. 
• Ownership Restrictions: Some entity types limit who can be an owner. For example, S-Corps can’t have more than 100 shareholders, and all shareholders must be U.S. citizens or residents (no foreign or institutional investors allowed). LLCs offer more flexibility but are less compatible with standard equity financing. C-Corps have no such restrictions, making them the go-to for startups with diverse or global ownership needs. 

Entity Types, Explained 

LLC 

 A Limited Liability Company (LLC) is a business structure that blends features of both corporations and partnerships. It's a popular option for small business owners due to its flexibility and the liability protection it offers. Multi-member LLC’s tax classification defaults to a “partnership”. However, elections can be made to change the LLC’s tax classification to C-Corp or S-Corp, subject to certain limitations, offering flexibility in tax planning. LLCs are relatively simple to manage and don’t require much ongoing administrative work. However, it’s generally not suitable for startups seeking venture capital. 

Pros

• Flexibility in entity tax classification 
• Simple to set up and maintain 
• Flexible ownership and management structure 

Cons

• Not compatible with venture capital or institutional investors 
• Members may owe self-employment taxes on profits 
• May require conversion to C-Corp for long-term growth or exit 
• Ineligible for Section 1202 (Qualified Small Business Stock) gain exclusion 

C-Corporation 

A C-Corporation is a separate legal entity that pays its own taxes and is the standard structure for high-growth startups, especially those seeking venture capital. It allows for unlimited shareholders, multiple classes of stock, and stock options, which makes it ideal for scalable startups. However, it comes with greater complexity and potential double taxation. Future capital gains realized in a qualified disposition may be eligible for Section 1202 gain exclusion if Qualified Small Business Stock is sold. 

Pros

• Preferred by VCs and institutional investors 
• Supports equity compensation and multiple stock classes 
• Scales well for growth and eventual exit 
• Share disposition for Section 1202 (Qualified Small Business Stock) gain exclusion

Cons

• Subject to double taxation (corporate income + shareholder dividends) 
• More expensive to form and maintain 
• Requires strict corporate governance and compliance 

S-Corporation 

An S-Corporation is a tax designation for corporations that allows profits and losses to pass through to shareholders, avoiding the double taxation issue faced by C-corps. It’s suitable for small businesses with limited ownership needs but comes with strict eligibility rules that limit flexibility. S-Corps are not viable for most venture-backed startups. 

Pros

• Pass-through taxation with potential self-employment tax savings 
• Provides liability protection 
• Good for U.S.-based, closely held businesses 

Cons

• Limits to 100 shareholders, all of whom must be U.S. individuals 
• Can’t issue preferred stock 
• Ineligible for most VC or institutional funding 
• Ineligible for Section 1202 (Qualified Small Business Stock) gain exclusion 

Comparison Table - Summary

The Process of Incorporating 

The first step in evaluating which legal entity is best for your startup should always be engaging a startup-savvy attorney, and potentially a CPA, to align your tax strategy, equity plan, and compliance obligations from day one. Although Delaware C-Corps are the standard for venture-backed companies thanks to investor familiarity and robust case law, incorporating in your home state can be cheaper and simpler, and may come with other benefits (for example, some states offer tax incentives for startups or startup investors that are incorporate in their state). 

Note that it is possible to convert from one entity to another. It’s not uncommon for early-stage startups to form as an LLC, take advantage of the lower administrative burden and pass-through taxation while they get started, and transition to a C-Corp when they take on new investors. However, converting from one entity to another adds legal costs and potential tax friction, so should only be done if there is a clear need or benefit in doing so.  

Conclusion 

Selecting the right entity type isn’t about finding a “best” option in the abstract; it’s about matching your startup’s vision, funding strategy, and growth horizon with the structure that minimizes friction and maximizes flexibility. LLCs offer simplicity and pass-through taxes for lean, early operations; C-Corps open the door to institutional capital and clean exits; and S-Corps split the difference for closely held U.S. businesses. Each choice carries trade-offs around taxation, ownership limits, compliance burden, and future conversions. 

Before filing any paperwork, map your fundraising timeline, ownership mix, and potential exit paths, then validate that plan with a startup-savvy attorney and CPA. A thoughtful choice today can save thousands in tax and legal costs and prevent headaches when investors or acquirers start their due diligence. Reach out to Founder’s CPA for tailored guidance on entity selection, tax strategy, and the nuts-and-bolts steps to incorporate with confidence.