Inc. or LLC?
What would you suggest for a startup?
26 comments
Startup implies rapid growth, which means you want to be a Delaware Class C Corporation so you can raise VC money.
An LLC is fine for a business where you expect to make your money from profits rather than a liquidity event and aren't trying to raise VC money.
An LLC is fine for a business where you expect to make your money from profits rather than a liquidity event and aren't trying to raise VC money.
According to this, it should be possible to convert an LLC into a Delaware corporation later: http://www.feld.com/blog/archives/2006/03/entity_conversa.ht...
Yes, but what's the point? Not that much difference in cost or maintenance time. And it is just one more hurdle to deal at a time when you don't need hurdles, e.g. when you are trying to close a funding deal.
I don't want to say that everybody should choose an LLC at first. Rather, if you're not 100% sure you'll get funded by Y Combinator or other investors soon, you can keep the LLC and its possible benefits under consideration even if you hope for the best. YMMV.
Based on what I've read, LLC in your legislation may have tax benefits, cheaper and easier setup process, and less yearly bureaucracy.
Based on what I've read, LLC in your legislation may have tax benefits, cheaper and easier setup process, and less yearly bureaucracy.
Just a note for potentially cash-strapped California startups:
CA collects at least $800 a year for all corporations operating in the state, however, S and C corporations are exempt in the first year while LLCs are not. That $800 is due about 120 days after incorporation and it's an annual minimum franchise tax, so you'd have to make like $9,000 profit your first year to recoup it.
CA collects at least $800 a year for all corporations operating in the state, however, S and C corporations are exempt in the first year while LLCs are not. That $800 is due about 120 days after incorporation and it's an annual minimum franchise tax, so you'd have to make like $9,000 profit your first year to recoup it.
An LLC shouldn't hamper you in an acquisition liquidity event. In fact, there are often tax benefits for the buyer vs a C corp. The reason not to do it is if you want outside investors. VCs just don't usually invest in LLCs as far as I can tell.
This will be a small to begin with, I just finished school and owe too much in student loans to quit my day job. An LLC is attractive for the low record keeping and tax paperwork requirements. One concern is that I see no legal framework for vesting built into LLCs, I'd rather not roll my own.
Has anyone looked into filing an operating agreement in Nevada instead of Delaware? Among other benefits, a cursory glance at the facts seemed to indicate that the tax burden would be lower in Nevada.
Am I missing something obvious?
Has anyone looked into filing an operating agreement in Nevada instead of Delaware? Among other benefits, a cursory glance at the facts seemed to indicate that the tax burden would be lower in Nevada.
Am I missing something obvious?
An LLC has shares just like any other corporation. You just keep giving shares to those who stay on and don't give them to those who don't. Stock options are another matter.
The primary point of incorporating in Delaware is for the outstanding legal and administrative structures they have for corporations. Not everyone is incorporated in Delaware -- Apple has always been a California corporation. But better to do it now rather than have to later.
In any state, the tax burden for a foreign corporation (one incorporated in another state) is going to be about the same as one incorporated in that state. That's because states have complete control over taxing revenue earned in their state, regardless of where entities are incorporated.
Nevada is business friendly, but since the state has no income tax, it also has a stigma of being quite popular with tax cheats. So it may increase the chance of an audit.
The primary point of incorporating in Delaware is for the outstanding legal and administrative structures they have for corporations. Not everyone is incorporated in Delaware -- Apple has always been a California corporation. But better to do it now rather than have to later.
In any state, the tax burden for a foreign corporation (one incorporated in another state) is going to be about the same as one incorporated in that state. That's because states have complete control over taxing revenue earned in their state, regardless of where entities are incorporated.
Nevada is business friendly, but since the state has no income tax, it also has a stigma of being quite popular with tax cheats. So it may increase the chance of an audit.
As per zach, the state where you're operating is going to impose income/franchise taxes regardless.
I've heard of strategies that involve multiple entities. So for instance you might form a Nevada entity that owns the IP and licenses it to the operating entity. The licensing/royalty fees serve to shift a fraction of your income out of state where it can't be taxed.
That's all I know. For us it'd be way too much hassle just to avoid (some of) the ~4% franchise tax.
I've heard of strategies that involve multiple entities. So for instance you might form a Nevada entity that owns the IP and licenses it to the operating entity. The licensing/royalty fees serve to shift a fraction of your income out of state where it can't be taxed.
That's all I know. For us it'd be way too much hassle just to avoid (some of) the ~4% franchise tax.
It's cheaper to have a corporation in Nevada. Delaware is popular because there is more corporate law precedent there.
I just inc'd in CA, I looked at LLC but that's a partnership and I'm doing this alone.
I went for the quick and easy route. I'm looking to build a good product not a big corporation. The less time I spend having to futz with the lawyer/Accountants and Tax man the happier I'll be.
I went for the quick and easy route. I'm looking to build a good product not a big corporation. The less time I spend having to futz with the lawyer/Accountants and Tax man the happier I'll be.
You can be the sole owner of an LLC.
If you are an LLC in Tennessee and operate as a foreign entity in PA as a corporation - not an LLC. Would this be legal? Would you have to file Articles of Incorporation or Amend Authority to do Business?
Please answer. Your response will be greatly appreciated.
Thank you.
Lynda
Please answer. Your response will be greatly appreciated.
Thank you.
Lynda
I went with an LLC, but I think it depends a lot on your situation. Mine is that I'm going it alone in many ways, and want to keep costs down, and don't foresee investments in the near future.
Why not a subchapter S if you wanted to keep costs down?
From what I read, non-US citizens/residents can't take part in S-corps, and since I am physically located in Europe, should I ever want to partner up with someone and include them in the company, perhaps it would be easier with the LLC. It also seemed like a slightly lower hassle way of doing things. I could be wrong, but in the end, after doing my reading, I just picked one and got on with it.
The reason most attorneys advise Delaware is that the precedents are strongest there. Furthermore, it makes long-term legal costs lower because most corporate lawyers are familiar with Delaware's nuances.
All corporations are C by default. You have to file a special from with the IRS to become an S Corporation. S Corporations are flow-through entities which are not taxed at the corporate level. The reason VCs require you to be a C Corporation is two-fold:
1. VCs like to have unilateral rights and terms to give them downside protection such as liquidity preference and preferential stock classes such as Preferred Shares. S Corporations are simpler entities which only allow a maximum of 40 shareholders - as your company grows and you give stock grants or options, this won't work. LLCs only allow 75 shareholders.
2. VCs will claim that a C Corp structure gives you more flexibility. This is marginally true, but LLCs give you the same flexibility with slightly higher administrative cost but you can maintain the flow-through status which is advantageous.
The real reason is they want preferred shares and special rights. Stay an LLC or S Corporation if you don't need institutional investors. Angels are happy to invest in well structured LLCs or standard subchapter S Corporations.
All corporations are C by default. You have to file a special from with the IRS to become an S Corporation. S Corporations are flow-through entities which are not taxed at the corporate level. The reason VCs require you to be a C Corporation is two-fold:
1. VCs like to have unilateral rights and terms to give them downside protection such as liquidity preference and preferential stock classes such as Preferred Shares. S Corporations are simpler entities which only allow a maximum of 40 shareholders - as your company grows and you give stock grants or options, this won't work. LLCs only allow 75 shareholders.
2. VCs will claim that a C Corp structure gives you more flexibility. This is marginally true, but LLCs give you the same flexibility with slightly higher administrative cost but you can maintain the flow-through status which is advantageous.
The real reason is they want preferred shares and special rights. Stay an LLC or S Corporation if you don't need institutional investors. Angels are happy to invest in well structured LLCs or standard subchapter S Corporations.
who are you? :)
Someone.
Whoever you are, thank you. Could you suggest any good books on the VC process? I'd like to be prepared if we decide to go that route.
You're most welcome. The best entrepreneur's legal guide is called "Entrepreneur's Guide to Business Law" published by Thompson / West Law written by Bagley and Dauchy. I bought it when I was doing my first start-up and I'm sure they have an updated version. I just found one at Amazon:
http://www.amazon.com/Entrepreneurs-Guide-Business-Law/dp/03...
In general, I think too many young entrepreneurs give up too much equity too quickly because they fall for the "oh we're making the pie bigger so giving us a huge percentage is fine" fallacy.
There are so many things to take into account when taking VC money. Too many VC firms replace young CEOs quickly at which point the founders get heavily diluted. Also be careful of VCs that try to reserve too large of a pool for management they want to recruit.
Management team members recruited by your VC work for the VC, not for you, the CEO. When push comes to shove, they will side with the VC because they know the VC will find them another job if your start-up goes bust.
The golden rule of VCs is this: He who has the gold makes the rule.
http://www.amazon.com/Entrepreneurs-Guide-Business-Law/dp/03...
In general, I think too many young entrepreneurs give up too much equity too quickly because they fall for the "oh we're making the pie bigger so giving us a huge percentage is fine" fallacy.
There are so many things to take into account when taking VC money. Too many VC firms replace young CEOs quickly at which point the founders get heavily diluted. Also be careful of VCs that try to reserve too large of a pool for management they want to recruit.
Management team members recruited by your VC work for the VC, not for you, the CEO. When push comes to shove, they will side with the VC because they know the VC will find them another job if your start-up goes bust.
The golden rule of VCs is this: He who has the gold makes the rule.
One more reason to stay a subchapter S Corporation if you don't need to raise VC money:
- There is a special election you can make when you sell the company that allows you to sell the assets instead of the equity which is something you can get the acquirer to pay more for because they can get a stepped up basis at market value and then depreciate it to create tax savings.
I don't remember the exact research, but I believe subchapter S corporations that undertake the election sell for 10% more than companies that cannot or do not take the election with all other things being equal.
- There is a special election you can make when you sell the company that allows you to sell the assets instead of the equity which is something you can get the acquirer to pay more for because they can get a stepped up basis at market value and then depreciate it to create tax savings.
I don't remember the exact research, but I believe subchapter S corporations that undertake the election sell for 10% more than companies that cannot or do not take the election with all other things being equal.
I believe LLCs also have this property (or something similar where a stepped-up basis can be achieved for the buyer).