LLC or S-corp for a 2 person California consulting company

This Q comes up sufficiently frequently that I blogged about it almost two years ago (Should I form an LLC or a corporation?). Here is the most important portion of that post:

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The following are the factors that, in my experience, are most likely to lead an entrepreneur to form a corporation rather than an LLC:

• An expectation that outside funding will be sought, especially from institutional investors (venture capitalists, in particular, tend to invest only in corporations).
• A desire to offer tax-advantageous equity ownership interests to employees and independent contractors (more straightforward to accomplish with a corporation than with an LLC).
• Prospective customers may feel that a corporation is more substantial and more “real” than an LLC (marketing and sales consideration).

The most significant disadvantage of a corporation is compliance-related overhead: The need to conduct annual shareholder meetings and regular board meetings and to prepare and file minutes for those meetings.

So what I have seen among my clients is: If none of the pro-corporation factors described above is present, the client forms an LLC to avoid the expense and effort associated with compliance-related tasks.

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Keep in mind that, with two founders (rather than one), whichever type of entity you create you will need to have in place an appropriate agreement addressing vesting of equity interests, buy-sell restrictions, and the like.

Disclaimer: This information does not constitute legal advice and does not establish an attorney-client relationship.

The one advantage that an "S" corp would have would be lower filing costs. The administrative headaches of "S" Corp vs LLC will make up for that in about two hours of work and you will need much more than that just to set up the more complex structure.

I would do an LLC. Dealing with S Corp taxes and K1s at the end of the year was never fun, for me.

I would also do an LLC, if not just because that's what most people would do. Either one would work though.

One thing to consider is protecting the company's business from the claims of your personal creditors (and those of your business partner.)

Shares of a corporation are considered property, so if a creditor sues you personally, he might be able to claim the shares of the corporation. This would probably have two bad effects: first, it would probably destroy the S-corp election, and second, it would mix the creditor up into the management of the company and the creditor would likely try to sell off the business to satisfy the debt.

An LLC can have something called "charging order protection," which means that your creditors can only get the money that the LLC would have distributed to you, but don't have the ability to take over whatever management rights you had in the LLC. Note, though, that this is an evolving area of law and can vary dramatically state-to-state, so it's best to consult an attorney.