Syndicated from My High Tech Startup
You’ve made your 2009 resolutions, and somewhere between “Be nicer to my in-laws” and “Floss once a week” is your goal of starting a new company.
Here’s to those 2009 resolutions… so what’s next to start that new company of yours? Well, you need to start… a… new… company. Okay, so what do you do? Do you need to file something with someone? Do you need to hire a board of directors? What should you tackle next? Fortunately (and unfortunately), you can find lots of advice from lots of people on what to do and not to do. Some will say definitely do an LLC. Others tell you to form in Delaware. Still others say that don’t bother forming a company yet.
So what is it? If you want to form a new company, what should you do? Well, those “experts” above are probably all correct in some way or for some businesses. In some cases, you don’t need to form a company for your side-project, but in others it is much better to form a C-Corp over an LLC. Sometimes a S-Corp is the way to go, while other times it won’t cut the mustard for a new company. Why you ask? Well… it depends. But, because it depends, you should get advice tailored to your business strategy.
Following the masses
Perhaps you’ve heard the statistics that more than half of all US publicly traded companies and more than 60% of the Fortune 500 are incorporated in Delaware. You might have also heard that many VCs prefer to fund Delaware corporations. Maybe someone once told you that “going public” is the easiest as a Delaware corporation. And, to heap on more evidence in favor of Delaware, you may have heard that Delaware has the most “business-friendly laws in the country.”
So, since it seems like most everyone is a Delaware corporation and you would like to raise VC money and go public, then I guess all that evidence just means I should form a Delaware C-corporation too, right?
Not so fast… Before you rush to follow the pack, take a moment to understand why it matters:
1) Your choice affects your tax rates;
2) There are varied cost and fee structures in each state;
3) It may be costly to change entities at a later point;
4) Third parties may prefer or require your company to be organized a certain way; and
5) The “Pain in the Butt” Factor – How easy and simple is it?
How to figure out what choices to make?
Whether you decide to consult with your advisors, your attorney or your accountant to determine the best form for your company or if you decide to forego the advice and go it alone, be sure you make a decision based on an understanding of how your choices affect the business and fit into your business strategy. Spending the time and money up front will help ensure that you make the right choices for your entity.
My two-cents (and take this with a grain of salt because I’m a lawyer): talk to a lawyer or accountant that works with companies like what you hope to become. If you want to build an iPhone application company, talk to a lawyer or accountant that has worked with an iPhone application company. If you want to build a medical device company, find a biotech lawyer and connect with them.
Now I’m not saying you should go right out and HIRE a lawyer or accountant yet. You may not need to hire anyone… but you should talk to them to help determine IF you should hire someone and to find out their thoughts on how you should start the business. So just set up an initial meeting and pick their brain about the right approach to starting up. I’ll say this, I’m nearly always willing to grab a cup of coffee with an entrepreneur… and most startup lawyers or accountants would likely agree.
These initial meetings are helpful for the entrepreneur and for your potential lawyer, accountant or other advisors. When I talk to an early-stage entrepreneur, I can usually tell when it makes sense for them to hire us now and when it doesn’t.
Either way, I tend to help guide them to think about how to structure their business that matches their end goals so that if, today or down the road, they want to hire us, we minimize the clean-up that needs to be done. If you know you’ll need to seek VC funding this year, I advise one approach and if you just think this will be your side-gig and you won’t need outside money, then I’ll usually guide folks another direction. As you can see, depends on the facts of the business and the entrepreneur.
There isn’t one right or one wrong approach, and usually lawyers and accountants can usually figure out how to fix a situation that has been structured imperfectly. But by starting up in the way that best fits your business strategy, you can save yourselves a couple bucks down the road… and who doesn’t want to save a couple bucks from their accounting or legal bills!
Does It Really Matter How We Legally Structure Our Business?
What could happen… We read somewhere that another successful entrepreneur said he was “double-taxed” on his c-corporation. He said that for his second company, he set up an LLC and then later converted the LLC to a c-corporation right before funding. Is this the right approach for us?
What to expect… Remember when considering how to structure your business, there is not one ‘right’ approach. Every new business will have differing timetables, goals, and needs, so it is important to create a legal structure that accounts for this. And while this successful entrepreneur is correct that a c-corporation is subject to double taxation (whereby the corporation is taxed and the dividends distributed are also taxed), not every new venture would benefit from this approach.
Structuring your business is an important first consideration – so be sure to get advice customized to your personal and business plans. While the upsides of using an LLC may avoid double taxation, conversions from an LLC to a C-corporation add additional legal and accounting expenses, and may yield headaches for potential investors. Some new ventures begin as s-corporations (which primarily involve a c-corporation making a filing with the IRS, as well as other structural steps) and later change to c-corporations by revoking that filing. Other businesses may consider creating subsidiaries. Each option has its own set of benefits and drawbacks. Careful up-front planning on your business structure will aid in later efforts of fundraising, equity ownership, and costs for third-party service providers.
In my next posting, I’ll lay out a few “Rules of Thumb” to consider when setting up your new business entity and then we’ll talk about whether to choose Delaware or another state for your business! Happy resolutions!
