S Corp vs. LLC for Restaurants: Which One to Choose?
So, you’ve decided to open a restaurant. Congratulations!
As you dive into the world of culinary delights and business ownership, one important decision awaits you: choosing the right legal structure for your establishment.
In this blog post, we’ll explore the pros and cons of two popular options: the Limited Liability Company (LLC) and the S Corporation (S Corp) for restaurants.
Grab a cup of coffee and let’s dig in!
The Simplicity of an S Corp for Restaurants
If you’re opening up a restaurant with just yourself, one other partner, the S Corp may seem like the easiest option, and it often is.
Its straightforward structure is designed for small businesses with a limited number of shareholders, who don’t need a complex ownership structure, and this is why it is our preferred entity structure.
With an S Corp, you can enjoy the benefit of pass-through taxation, meaning the business itself is not taxed, and the profits and losses flow through to the individual shareholders’ tax returns. And, because owner’s in an S Corp are also employees and receive compensation through normal payroll checks, all flow through profits are exempt from self-employment tax.
This can simplify your tax reporting process.
However, it’s important to note that an S Corp is not well-suited for complex stock arrangements, a large number of investors, or multiple restaurant locations, for that matter.
With an S Corp, all profits, losses, distributions are shared based upon the % ownership each shareholder has. Let’s say you have a key employee who is going to open up a new territory for your business and you decide to give them 5% equity in the company. That key employee now shares in 5% of the entire company’s profitability and shareholder distribution payouts.
If you envision a more complex ownership structure or plan to involve investors or multiple locations for your restaurant, an LLC might be a more suitable choice.
Unlocking the Potential of an LLC for Restaurants
For those who want to explore a more flexible and adaptable stock structure, an LLC might be the ideal choice.
An LLC provides the flexibility and versatility you need to construct complex ownership arrangements and a diverse group of investors, but at an additional cost since flow through profits from the business are treated as earning from self-employment and incur self-employment tax.
Unlike an S Corp, an LLC allows for different classes of stock, enabling you to customize ownership rights, profit-sharing arrangements, and voting power.
Within an LLC, you have the freedom to categorize your shareholders into distinct classes based on their roles and interests.
Class A typically represents the main owners, with voting rights and other privileges. They are the decision-makers who steer the direction of the restaurant.
On the other hand, Class B may include outside investors who have a share of profits and losses but lack voting rights, and Class C could have no share in the equity of the company and only receive a share of profits.
This differentiation empowers you to allocate benefits and responsibilities according to each class’s specific role in your restaurant’s success.
Let’s look at a few examples of how you can use a restaurant LLC to your advantage.
Restaurant LLC: Protecting Your Brand and Assets
One significant advantage of organizing your restaurant as an LLC is the ability to separate your brand from its performance.
By creating a separate class to hold the brand, you can offer investors the opportunity to invest solely in the location’s profits, rather than the overall brand value.
This distinction can be invaluable when negotiating the sale of your restaurant in the future.
With an LLC, you can assign different values to the brand and the individual locations.
For example, let’s say people buying your restaurant value the brand at 10% of its total worth, which amounts to $1 million. Your outside investors would not receive any of this allocated sales price since they have no right to the brand.
With an LLC, you have the flexibility to dictate the value of the brand through different classes of shares.
This allows investors to focus on the specific location’s profits, aligning their investment with their desired outcomes.
Restaurant LLC: Ownership for Different Locations
Next, let’s talk about how flexible you can get with a restaurant LLC when it comes to multiple locations.
Let’s suppose your restaurant expands to multiple locations under the umbrella of a single LLC.
In this case, you can further refine ownership arrangements by classifying each location differently.
This opens up exciting possibilities for investors, as they can choose specific locations from which they want to derive profits.
By having different classes of shares associated with each location, you grant investors greater control and a more targeted investment strategy.
This approach not only benefits investors but also provides you with more control over the direction of each location.
For instance, if one location requires additional capital for expansion, you can allocate shares from a specific class of investors who are interested in that particular location.
This strategic allocation of ownership rights allows you to attract the right investors for each location’s unique needs.
Restaurant LLC: Getting Even More Creative With Ownership
When it comes down to any kind of creative ownership arrangement, the LLC truly shines.
While we don’t necessarily recommend getting overly complex, the flexibility offered by an LLC enables you to get clever with ownership structures and create customized agreements.
Here’s another scenario to consider.
Maybe you have a really talented chef in your restaurant, and ask for them to come up with a new and innovative seasonal menus.
To recognize their contribution and incentivize their creativity, you can grant them ownership of the profits generated by the items on that specific menu. Without giving away any equity in the business or share of the profits from the rest of the restaurant’s operations.
This arrangement allows the chef to share in the success of their creations while maintaining the overall ownership structure of the restaurant.
It’s worth noting that implementing such arrangements requires careful legal and financial considerations, and will incur additional legal feels to draft up the proper documentation.
However, an LLC provides the framework to make it possible.
Get More Help With Restaurant LLCs & S Corps
In the realm of restaurant ownership, you’re going to make a lot of critical business decisions.
And deciding between an LLC and an S Corp is one of the most important ones you’ll make because it can impact investors, capital, employees, your exit strategy, and taxes.
Trust us, it’s that big!
While an S Corp offers simplicity for small ventures, an LLC opens up a world of possibilities with its flexibility and stock structuring options.
If you aspire to have a complex stock arrangement, involve employees and investors, or protect your brand while allowing for expansion, an LLC is likely the better fit.
But our biggest piece of advice?
Get the help of an experienced restaurant accountant to help determine the best structure for your specific situation.
Don’t go by just a few words in a blog post!
We’re always here to help you make important financial decisions.
You can book a complimentary call with our accounting team by filling in the form here or booking a meeting down below.
Have a question that we didn’t answer? It’s what we’re here for!
Until next time.