Is there a consensus on the best type of corporation for a startup? Is it best to start with a Limited Liability Corporation (LLC)? Would an S-Corp be better? Or is it best to go with a full C-Corp?
I know there are several factors to consider, including things like ownership and taxes.
I will attempt to address here what many business owners don't know, but should know.
PERSONAL LIABILITY. As a business owner, you may be exposed to personal liability for activities related to your business. As such, your personal assets may also be exposed to the risk of attachment, seizure and sale. To reduce the risk of personal liability, consider creating a separate legal entity for your business and file a Declaration of Homestead (if applicable in your jurisdiction) for your primary residence.
CHOICE OF ENTITY. There are several ways you may create a separate legal entity, including, establishing a Corporation or a Limited Liability Company [LLC]. Factors involved in deciding which business formation is right for you, include, the following: is there foreign or US ownership of the business; how many owners of the business; is the business involved in international or domestic transactions; and other related issues.
SEPARATE IDENTITY. In giving birth to a new Corporation or an LLC, you are, in the legal sense, giving birth to a “Person” with its own identity, its own tax identification number, and its own liability. One of the keys to reducing the risks of third parties “piercing the corporate veil,” is to treat the new entity as a separate legal Person. For example, open a new bank account for the new entity and all funds should be maintained separately, and avoid commingling business funds with the owners’ funds. There are other ways in which the corporate veil can be pierced, such as under capitalization, engaging in activity that you know or should know will damage another, etc.
Also, purchase orders, letterhead, receipts, labels, advertisements, signage, contracts, etc., should reflect the full legal name of the entity, including the suffix (“Inc.”, “Corp.”, “LLC”, etc.). In addition, as an Officer or Director of the Corporation or a Manager of the LLC, each contract or other document you sign on behalf the business should be signed with your title describing the capacity under which you are signing, for example, “Sarah Smith, as President of Smith Wholesalers, Inc.” Any contract signed without such language may be deemed to have been entered into by you personally and any liability arising out of such a contact may be outside the scope of corporate or LLC protection.
Typically, there is more paper work associated with corporate compliance than LLC compliance, in that there are additional formalities required in maintaining an “Active Corporation.” For example, a corporation must file the Articles of Organization, draft By-Laws, conduct annual Board of Directors meetings, keep records of meetings, file Annual Reports (different from financial Annual Reports) with the Secretary of State, etc. One basic rule to remember is that, in order to have the protection of a Corporation you must “act” like a Corporation. Simply filing the Articles of Organization with the Secretary of State and paying the filing fee is not enough to protect you. To establish a Corporation in Massachusetts, the filing fee for the Articles of Organization is generally, Two Hundred Seventy-Five Dollars ($275.00). To maintain a Corporation in Massachusetts, the Annual Report filing fee is approximately One Hundred Twenty-five Dollars ($125.00) each year.
With regard to an LLC, there are less formalities required, e.g., (depending upon your jurisdiction and operating agreement) typically, no annual meetings or minutes are required. To establish an LLC in Massachusetts, the filing fee for a Certificate of Organization in Massachusetts is Five Hundred Dollars ($500.00). To maintain an LLC in Massachusetts, you must file an annual report each year and the filing fee is Five Hundred Dollars ($500.00) each year.
DECLARATION OF HOMESTEAD. Other means of protecting your personal assets include, filing a Declaration of Homestead (if recognized and applicable in your State). As an example, in Massachusetts, a proper filing of a Declaration of Homestead at the appropriate Registry of Deeds, protects the equity in the primary residence of the owner/declarant from certain creditors, up to Five Hundred Thousand Dollars ($500,000.00) per family (over 62 years old the protection is $500,000 each.
Take steps to protect yourself and the assets you have worked hard to acquire and remember, even if you don't have a lot of assets today, judgements granted today could be enforceable for up to 20 years. Create a separate legal entity and file a Declaration of Homestead (if applicable).
Disclaimer: This article is provided for informational use only. This article is not intended to be and is not legal advice. Consult an attorney with regard to the specific details of your situation. Filing fees may change.
Myth: Corporations protect you from lawsuits. Not at all. They protect your personal assets from being involved in bankruptcy. Do not incorporate because you think it protects you from anything else.
As with all good questions, the answer depends on your situation. Here are some key points to consider (if you don't want to read the whole thing, skip to where it says the bottom line)
Some options that are recommended for small businesses:
Sole proprietorship - good for a lemonade stand... No paperwork needed, but full liability
General partnership - Good for a lemonade stand with many owners... Liability is shared by all partners
Limited partnership - One of the partners holds all the liability, others don't (how VCs are built, general partners hold the liability, limited partners have limited liability)
It starts getting interesting with:
LLC - limited liability company - combines the features of both a corporation and a limited partnership.
- all owners have limited liability
- tax gains and losses pass though to LLC members (great if you can take advantage of that)
VCs choose not to back LLC because they cannot grant stock options. In addition, VCs want an IPO, which requires a corporation. It is possible to turn an LLC into a C corp, but that requires time, money and paperwork... If you plan on going public, go C-corp
S corporation - a corporation where tax benefits and losses pass though to individual shareholders, however, there are some limitations, like a cap on 100 share holders and only one class of stock (no preferred stock)
VCs cannot back S corps for two reasons:
1) shareholders can only be people (not partnerships or organizations)
2) The number of shareholders is a limitation
That leave us with the C corp, which does have double taxation (the corp pays taxes for the profits and the shareholders pay taxes again for the dividends), however it is VC and IPO friendly
One more things left to consider, and that is where to incorporate, and the answer to that usually is Delaware, since it has sophisticated case laws which is usually management friendly as oppose to share holder friendly, and it will make finding a lawyer much easier (all corporate lawyers know Delaware law, as oppose to other states which only local lawyers would know about).
The bottom line - For high tech companies wanting to raise money from VCs and an IPO, go for a C corp, and do it in Delaware. If you want a small company, go for LLC (also in Delaware :) )
Although Jason advised a DBA for a single-person company, my advice -- which is predicated on the fact that this is a serious, bona fide business you wish to run -- is to always establish a corporation. This puts you in the proper frame of mind and establishes the framework for when it comes time to hire someone, take out a business loan, etc.
But keep in mind, no matter what type of corporation you form, you need to run it as a separate entity from your personal life if, for no other reason, then to realize the liability protections that a corporation offers. If, for example, you don't have a business bank account, EIN/TIN number, articles of incorporation, regular board meetings, etc., it's going to be difficult to argue that it is a seperate entity from yourself.
That said, your best bet is most likely an LLC/S-Corp. There may be a few reasons to go C-Corp beyond what Jason said (primarily tax planning, such as having your health care costs paid by the company), but the paperwork costs will be much more.
The best advice I've seen online for this is Yokum's:
What type of entity should I form?
C corps, LLCs, and S corps differ significantly in the areas of taxation, ownership, fundraising, governance and structure, and employee compensation. Almost all technology startup companies that I work with are C corps. Any company that raises venture financing will need to be a C corp in order to issue preferred stock.
If founders want the benefit of flow through tax treatment with respect to losses prior to an outside financing, an S corp election may make sense as long as there are no entity or non-U.S. citizen/resident stockholders. However, S corp losses can only be used to offset personal income up to the founders’ basis in the S corp stock, which may decrease the utility of the S corp election. In any event, the S corp election can be easily revoked at the time of a financing. The legal documentation for an S corp is basically identical to an C corp.
I generally avoid LLCs as most technology startup companies need to grant options to employees and consultants, and there is no easy “off the rack” method to do this. In addition, the conversion of an LLC to a C corp results in additional legal and accounting expense. However, LLCs may make sense for businesses like consulting companies.
The primary differences between C corps, LLCs and S corps are outlined below.
Read the rest of the post here.
There is a key reason that has not been answered yet.
An old rule and the number might be greater now days. If you make over $100,000, Incorporate. Why do a DBA and pay premium in personal taxes?
Of course pay your share of taxes every year. But why not also take advantage of some write-offs that you can only get from a corporation. A key selector of which type of S or C or LLC to use is how much you make and how you want to do your tax write-offs.
All the above is great advice. Besides liability and taxes, you should clearly understand the governance issues, or how the power to make decision is legally apportioned. I have a white paper posted at one of my websites entitles "Small Company Structure and Partnership Questions " that you are welcome to download. It discusses the roles of owners, directors, managers and officers in different entities.