What kind of incorporation is best for a 3 fouder start up?

Misha Britan

January 23rd, 2015

Is it LLC, C or S corp, or is there a magical combination of the benefit. 
We would hope to take in angel and VC money at some point. 

Annie Webber Founder and CEO at Legal Hero

January 23rd, 2015

Misha, If you're looking to take in VC money at some point, they'll most likely require you to be formed as a Delaware C-corp. We'd be happy to help you find a lawyer to incorporate your business and to put all of the necessary agreements between co-founders in place. Also, if you're still trying to figure out how to split the equity among your co-founders, check out this article and calculator we've posted on our blog . Good luck! Annie

Scott Milburn Entrepreneurial Senior Executive and Attorney

January 23rd, 2015

Speaking as both an entrepreneur and a lawyer, I ampleasantly surprised by the number of comments that recommend an LLC! I was expecting all the usual "you have to be a DE c-corp." comments. As some have suggested, an LLC is easier to form and manage (no requirements for annual shareholder meeting with minutes, regular board meetings with minutes, etc.), and you have more flexibility in having varying rights for voting, profit sharing, etc.

It is true that at some point you may need to convert to a c-corp (an S corp is just a c corp with a special tax election for federal tax purposes), but that is easy to do when it becomes necessary. At that point, you can also decide if there is any justification for incorporating in DE (in reality, there rarely is), but you may as well put that decision off until you need to make it. Just form the LLC and start building your business without worrying about observing all the formalities of a c-corp.

Also, note that when it does come time to convert to a c-corp, the S corp election question is something that your CPA will guide you on, because it depends on your corporate and personal financial situation, and how you want to be taxed.

Alan Matthews Entrepreneur

January 24th, 2015

While everyone here means well... they're not all correct!

From your perspective, either an LLC, or Sub-chapter S will work. Investors won't demand that you convert from an LLC to a C-Corp, as mine didn't (Bain Captial) or though some might... in any event a ways down the road that you probably won't need for a year or two.

The reason that an LLC is best (imho) is because you can disconnect the investment dollars from the losses to allow owners of equity and capital different allocations of loss.

Let's say two people start a company, person A puts $100K into it and person B puts no money in but the agreement is that B will work and A will be the capital. If the equity is shared 50/50 then in a Sub-S scenario partner A gets allocated 50% of the loss, but has 100% of the basis or investment and so loses the opportunity to deduct the 50% remaining of the loss that was allocated to partner B.

B has no basis so can't deduct the $50K because his investment is time, not capital.

Under an LLC scenario, partner A can deduct all $100K loss even though they only own 50% of the "company".

I've used this structure more than half a dozen times over the years to provide this unequal distribution of loss to the capital partners.

Best of luck.


Michael Brill Technology startup exec focused on AI-driven products

January 23rd, 2015

If you expect to raise money before incurring significant expense then just cut to the chase and spend your $500 on a DE C Corp. You don't need pass-through advantages of the LLC or S Corp, and why have the extra hassle and expense of conversion? Creating a C Corp with all the stuff like founder stock purchase agreements, 83b elections, etc. is easier than setting up your dev environment with online services. The additional overhead of having a board meeting is 10 minute affair. Other reasons why you want a C Corp:

* I'll wager that it's faster and easier to do a full C Corp setup with all of the support documents you need (founder stock purchase agreements, confidentiality, IP Assignment, etc.) than it is to do an LLC - that's because there are services that already have all this stuff packaged together for your garden-variety tech startup C Corps.
* Standard documents for things like advisor agreements assume a corp. With, say, an LLC you then have to talk to the advisor about your structure and how it will convert, etc. It's time-consuming and looks amateurish.
* The optics extend to raising money. Let's say you get an interested investor who simply asks you what your structure is. It's a small issue, but when someone says they created an LLC because it saved a few dollars, it's a tell that they aren't confident enough. A C Corp says you're ready to go.
* It's just good to understand how a C Corp works. Cap tables with multiple classes of stock, voting rights, corporate governance, etc. Look, you'll need to understand things when you take investment, so why not just start with that?
* If you're splitting the costs three ways, it makes it that much more obvious to just do a DE C Corp.

Starting with an LLC or S Corp can make sense in some cases, but not most startups on this site. It's kind of like learning, say, Visual Basic first because it's easier than [insert popular modern language here]. Fine, you get started a bit quicker but when you need to do something real, then you've got to switch over and learn something else. Life's too short.

Ramesh Barasia Certified Business Coach | Help Business Owners Get More Money, Time, & Freedom

January 23rd, 2015

simple, you have no choice but to go C-corp route if you are going to have investors and VCs. LLC is a pass through and less suitable when stocks and shares are involved. S-Corp is also a pass through and therefore VCs and investors will be reluctant to invest. *Ramesh Barasia* CEO, TAB North Atlanta 205 Bright Water CV, Suite 100 Johns Creek, GA 30022 Office: 678-812-1201 | FAX: 770-521-5307 Mobile: 770-309-3971

Misha Britan

January 23rd, 2015

Thanks Brent and Tom. 
And would you say that Delaware is state to do it in, or the one where the address will be listed? Thanks. 

Brent Laminack Principal at OpenFace Systems, Inc.

January 23rd, 2015

As always, I suggest S corp, as you get the flow-through benefits of an LLC and the ability to take dividends instead of regular income as an S, thus getting the tax advantages of both.

Tom Maiaroto Full Stack Consultant

January 23rd, 2015

S corp is what investors will likely want you to do though. However there's nothing wrong with an LLC. In fact I recently read something about how investors now are more "ok" with LLCs.

One thing to consider is doing an LLC first and converting later. If you setup a different corporation type, you could be hitting any co-founders (or other people you assign equity to) who come on board later on with an immediate tax burden. Fun fun.

Aditya Rustgi Using AI to solve information overload.

January 23rd, 2015

Hi misha, If you aim to get investors for your venture you will be required to have a corporation. You don't have to form a corporation right away, ie you can start with an LLc but before you have investors it will need to be turned to a corporation. You will have to get lawyers involved at that time because it's not trivial. You can choose to start as a corporation but being a corporation has some legal and fiduciary obligations that you should be aware of. Finally you should get the advice of a lawyer before you take any step. It may cost you a bit in the short term but in the long term it will save you a lot of headache. Sent from my iPhone

Michael Brill Technology startup exec focused on AI-driven products

January 24th, 2015

There are always a ton of assumptions built into to these answers... mine is that there is neither a significant amount of capital invested by the founders nor is there significant amount of losses to pass through. It's the three people building an MVP, getting initial users/customers, getting angel money, finding product/market fit, getting Series A, and you know the story. If you don't raise any money in, say, 9-12 months then it basically falls apart and you move on.

In that scenario, you don't need the flexibility to divorce equity and distributions. Sure you *could* create an LLC, but I can't imagine it makes sense to create all the extra hassle and friction when you don't need to - it really doesn't save that much time or money. But early-stage investment is emotional and intuitive and optics matter. People hate any complexity in the investment process. Sure, if your story is strong enough then it doesn't matter... but it's like getting a face tattoo before your pitch - it isn't going to help you.

Alan is obviously right that different structures make sense in different cases and based on your investors. In my previous company we *had* to create an entity that separated ownership and capital distributions - an LLC was the best structure. Am working on a wine crowdfunding site now and, again, for certain types of projects we are using a Series LLC. I could have done both of these with a corporate structure but it would have been much more painful for everyone.

So, (1) no face tattoos and (2) make it easy for people to invest in you.