The ABCs (and LLCs) of Corporate Structures

As an entrepreneur one of the first things you must do is formally "incorporate" your company. Thanks to the internet there are a myriad of sites (one being Incorporate Fast) that enable you to file for incorporation quickly and easily. What might be more complicated is deciding on which corporate structure to use. My first piece of advice in this regard is to find yourself a good lawyer; definitely one who has raised private equity (venture funding or angel funding) on behalf of other clients, preferably many times over. If you think that you can't afford to hire such expertise, I would argue that you can't afford not to. Experienced deal lawyers are worth every penny; they've been there and done that. They're not learning on your dime, which ultimately, will save you money. As for incorporating, you have three choices (1) C-Corporation, (2) S-Corporation and (3) Limited Liability Company ("LLC"). It's important to take the time up front to understand the pros and cons of each choice and how they map against the goals and objectives you've set for your venture. Your lawyer can be very helpful here. Of the many issues to consider when choosing a corporate structure, two of the most important are: (1) the type of investors you're seeking (both now and in the future) and (2) taxes. Forming an S-Corp will help you avoid double taxation, but won't allow you to issue two classes of stock, which is important if you plan on raising money from angels and/or venture funds. Choosing an LLC allows you to issue multiple classes of stock but they will need to be called "units" and the shareholders will be called "members." This can make certain institutional investors uncomfortable. LLCs also can generate something called "unrelated business income tax" or UBIT, which institutional investors hate. Choosing a C-Corporation will subject your company to double taxation (i.e. net income of the corporation is taxed and then any dividends provided to shareholders are also taxed). But this may not be an issue in the early years since net income is most likely going to be negative. It's important to note that there is no "right" answer when choosing a corporate structure - you may end up starting with one type and ultimately changing to another. An experienced deal lawyer will be invaluable as you navigate this path. An expectation of receiving a JumpStart investment is a willingness to take your company down the high growth path (i.e. you must be focused on raising angel or venture funding, or both). As such, prior to closing an investment, we require our portfolio companies to adopt a corporate structure that is friendly to follow-on investors, either an LLC or a C-Corp. Keep in mind that while angels can (and often do) invest in both types of entities, venture funds are generally only allowed to invest in C-Corps. For some additional information on this topic here are a few helpful sites: S-Corp's vs. LLC's from Feld Thoughts LLC vs. S-Corp vs. C-Corp (The 3-Minute Version) from Taxes Made Simple Form a Corporation Learning Center from Incorporate Fast S-Corp's vs. LLC's from What I Learned Today