For many entrepreneurs, their first experience with corporate law occurs when they decide to organize their fledgling business into one of the several forms of business entities permitted by law in most states. For the first time business owner, the options presented by legal counsel can be confusing, in part because the differences among some types of business entities are subtle or highly technical. The appropriate form of entity can depend on numerous factors, including the nature of the business, its intended ownership and management structures, the desired tax treatment of income and losses and the importance of limiting the personal liability of the business’s owners. The good news is that for nearly all start-up businesses the choice of entity can be narrowed down to two options – the corporation or the limited liability company – and for start-up technology businesses, organizing as a corporation is usually the best option.
Corporations and limited liability companies (generally referred to as “LLCs”) offer two major advantages relative to other forms of business entity. First, corporations and LLCs afford their owners maximum protection from the liabilities incurred by the business. In most circumstances, the liability of the owners of a corporation or LLC (“shareholders” or “stockholders” for a corporation and “members” for an LLC) is capped at the value of their investment in the company, meaning that the personal wealth of the owners is not at risk, even if the business goes belly-up. Second, with a corporation or LLC it is possible, subject to satisfying certain conditions, to choose whether the income of the business will be attributed directly to the owners, and therefore taxed at each owner’s applicable individual tax rate, or taxable to the company. Before forming your company you should discuss with your tax adviser which tax treatment is most advantageous for you and your business.
While corporations and LLCs are similar in many respects, there are several reasons most technology businesses choose to organize as a corporation. One reason is that equity incentive grants (e.g. stock options) are simpler to make from a corporation than from an LLC, which is important because most start-up technology businesses rely on stock options as an important element of the compensation they pay to employees. A second reason is that venture capitalists generally prefer to invest in corporations rather than LLCs, and while it is possible to convert from one form of entity to another, this adds time, cost and complexity to a financing transaction.
No matter what type of business you are starting you need to consider your specific circumstances before choosing the best form of business entity for your business.
Remember that the discussion above may not cover all of the factors relevant to your decision, so you should consult a lawyer if you have any questions.
Tags: by-laws, bylaws, C Corp, Charter, Formation, founders, S Corporation, Startup, Stock options
Tags: by-laws, bylaws, C Corp, Charter, Formation, founders, S Corporation, Startup, Stock options