Tech Law Basics (U.S.) - Vol. 1: Incorporation
I thought I'd write a few posts on basic technology (fintech) corporate law, including topics like incorporation, regulatory issues, tax, employment law, litigation, etc. [Note: these all are aimed towards readers in the United States.]
This first one is about something quite straightforward: Incorporation of your company.
So you want to start a company but not sure where to start? Let Bully help!
Why Incorporate?
Liability. The primary purpose of incorporation is to limit your personal liability (as opposed to your business's liability). If you start a business without creating a legal entity and you get sued while performing services for that business, your personal assets (e.g. your car, house, savings) could be at risk in the lawsuit. Incorporation protects you from personal liability (in most circumstances) and ensures that any losses are attributable only to the business. LLC is an acronym for Limited Liability Company, after all.
There are other compelling reasons to incorporate, including generally favorable tax treatment, the ability to issue shares, set rules for the business (bylaws), hiring employees, etc. But the best reason, imho, is limiting the liability of the business to the assets of that business.
Where Should I Incorporate?
Most likely Delaware. Delaware is the best place to incorporate a company because that's where most companies incorporate. This sounds circular, I know, but over the years companies incorporated in Delaware so Delaware courts/legislature became experts in general corporate law. The jurisprudence in the state is the most developed, because that's where all the companies take their disputes. Delaware regulators tend to be the most sophisticated because they have the most experience. The fees are low and the statutes and courts are business friendly.
If you're only looking to start a simple small business only in your home state, however, it may make sense to incorporate in your home state.
What Corporate Entity Should I Chose?
It Depends =) Classic lawyer answer, I know, but it really does depend on what you're trying to do. I'll give a quick overview of the different types of corporate entities:
LLC (Limited Liability Company) - LLC's are great when you don't need anything particularly fancy. I usually suggest them to people who just want to start a small business and who will probably not need to go out and raise capital (e.g. a landscaping company). A significant advantage to this format is that profits and losses from the business can be "passed through" to owners without double taxation (like a partnership) but limits liability like a corporation. Corporations (except s corps, see below), for example, are taxed twice (the corporation itself is taxed on the income and the shareholders are taxed on the returns). LLCs are quite flexible and allow for a variety of different structures.
Keep in mind that most venture capital firms will not invest in LLCs due to tax reasons not worth discussing here. But if you're thinking about raising money, a corporation is likely the better play.
C Corp (Inc.) - Corporations are the gold standard for corporate entities in the United States. They are well-established from a corporate formality POV and offer a variety of advantages over LLCs, including the ability to issue (multiple classes of) shares and nominate directors and officers. As noted above, corporations are taxed as an entity, rather than directly via its owner(s), though owners also pay income tax on profits.
Corporations have more signifiant reporting obligations and corporate formalities than LLCs (incl. holding reoccurring meetings, filing annual reports, etc.), however, which need to be considered.
S Corp - S corps are corporations that can elect to have the flow through taxation treatment of an LLC. There are important restrictions, however. S corps are restricted to no more than 100 shareholders, and all the shareholders must be US citizens. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. So it gets really tricky to ensure you're complying with these restrictions, particularly as the cap table swells. Also, you can only have one type of stock, which makes VC investment tricky.
Partnership - Unless you're a professional (doctor, lawyer, dentist) and are statutorily precluded from limiting customer liability (for public policy reasons -- i.e. customers need to be able to sue doctors and lawyers for malpractice), there's no good reason to have a partnership. I wouldn't recommend a partnership for most people.
Conclusion / Resources
You can do it yourself, but if you're not an attorney you'll probably fuck something up. Make sure to seek professional help. In the meantime, here are some resources:
Here's Delaware's help page: http://corplaw.delaware.gov/
Also check out Clerky: https://www.clerky.com. Clearky is cheap and makes incorporation super easy.
