Ask HN: Best legal structure for "different" type of startup | Hacker News Reader

Ask HN: Best legal structure for "different" type of startup

2 pointsUSNetizen5 comments

So I have a bit of a legal question (but I know the standard disclaimer - I do not expect people answering to offer official legal counsel or advice, etc. and I should speak with my attorney/CPA - which I am next week but I've been getting a lot of conflicting messages from them).<p>So, long story short, I'm starting another company. We work primarily with the federal government and other large enterprise agencies on contract. I've been told by many SBA (Small Business Administration) counselors that I should forget completely about forming a corporation, and go directly to LLC due to their simplicity to operate. However, I've been spooked because the company I last partnered with had issues raising funding using an LLC structure and other entities/people seemed to see an LLC as less credible of a business structure.<p>That being said, I'm going to be working with a vendor (the government) where reputation and credibility is everything. I'm leaning heavily towards a Delaware S Corp, which can then be converted to a C corp later on so I can offer tax-deductible benefits to employees (compared to an LLC where employee benefits are taxable to them). The word "corporation" just sounds a lot more reputable to me and I assume clients in a risk-averse setting would see it the same.<p>Any thoughts on that?

LLC vs. Corporation has nothing to do with credibility. That this is even consideration is an indication of poor advice you have received so far. Nobody that deals with the entity should care whether it is a corporation or an LLC or Limited Partnership. There are giant multi-billion dollar LLCs, typically divisions of some parent corporation. LLC simplicity makes it easy for LLCs to be divisions of a parent corporation.

Why Delaware? Your own state's corporation laws are good enough unless you're already gigantic or going public, or already are in Delaware, or someone is specifically demanding it from you, which I strongly doubt. Plenty of gigantic, or public companies do not incorporate in Delaware. Why do you need to have a foreign-state incorporation rather than your own state? Make it simple and less expensive, and use local-state incorporation and local lawyers that are familiar with their own state's run-of the mill corporate laws. Delaware is not that special.

A Limited Liability Company form of entity can be simple to operate, but they are not flexible in having the ability to have multiple classes of investments by others.

If you're the only person, or one of several individual partners, and capital from other people is not a concern, then, sure, an LLC may work for you. Later on, if you have a partner-founder depart, and want to issue a different category of capital representation for him/her upon departure ("units" in LLC speak), you can't, so LLCs are not so good at transitions either. Creating a vesting process may also be cumbersome or not possible. Further, if you grow and need capital, you'll end up becoming a C corporation, to be able to have multiple classes of ownership shares.

C Corporations vs. S Corporations: these are elections that are made via a filing with the US Internal Revenue Service. The S Corp has limitations on what it may do and and still maintain its status as an S corp for tax purposes, instead of the default C corporation status.

If you are seeking investments or venture funding: VCs and investors prefer C corporations: the investor will not be taxed on net income as they would with an S Corp. The C corp. can issue convertible preferred stock, which is typical structure for a venture capital investment. S corporations can only issue one class of stock, so that also is typically a deal stopper for investors.

Venture Capital funders don't like LLCs or S Corporations for the above reasons, and will decline to participate, unless the entity converts to a C corporation.

Correction. You can have multiple kinds of LLC units or shares defined. But LLC flexibility can be an impediment, since new classes creation will involve sign off / agreements with existing unit holders, and restructuring the existing LLC membership structure.

It all boils down to, what are your likely financing structures, if any, and how likely will you later on need to become a C Corp. Be wary of subsequent entity conversion tax issues for owners and entities as well.

Here's a survey of only some of the issues: LLC, C corp. and S corp.

Choice of Entity - Startup Law Blog - Joe Wallin, Davis Wright Tremaine LLP (undated, but apparently 2012)

http://www.startuplawblog.com/choice-of-entity/

Well, here's the problem I found: LLCs are not treated consistently by all of the states, and I will be doing business in more than one state (actually having a physical presence in multiple states). Therefore, that is the reason for a DE incorporation and my thoughts on using an S Corp (which I can at some point check the box and change back to a C Corp). The "credibility" issue I spoke of also applies not just to investors, but bankers have also been more hesitant to loan to an LLC. I saw this with a previous LLC entity I was a partner in.

Also, benefits paid to employees through an LLC are fully taxable income to them, whereas with a Corp (either S or C) they are tax deductible (for employees owning less than 2% of the company).

Furthermore, the stock ownership ("units") situation with LLCs is awkward at best, like you said, so forget about incentive stock options and the like. I understand the simplicity and have used the LLC structure before for other reasons, but never for a multi-state entity.

Great input, thank you.

Some questions to pursue with your advisers:

What are the tax issues upon dissolution/merger/conversion of entities from one to the other, for the owners and the entity itself?

Is there an impediment to rapidly converting a Subchapter-S corp into to C-corp - are there be any delays, fiscal year issues or alignments, or other IRS filing or election issues and impediments, again for the entity and for owners?

For foreign LLCs in terms of the "corporate veil" and limited liability, etc., set up in state Z, how does the foreign LLC get treated in other states of interest, states A, B, C, and D compared to the foreign corporation set up in state Z, operating in states A, B, C and D? Do those several states follow the IRS-election for taxation of local-state activity?

What advantages / disadvantages for the LLC to elect to file with the IRS the "filing as corporation" status, instead of the default sole proprietorship/partnership status, or --yes you can elect this too-- "Subchapter-S"?

I am not a tax attorney, but I've never heard of employee benefits being treated any differently in an LLC versus an S or C corp.

Edit: After looking it up, benefits paid to employees receive the same tax benefits as other structures, BUT shareholders/partners are taxed individually on the benefits they actually receive. Non-ownership employees won't have the problem. But again, I am not a tax attorney or accountant.

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