We're incorporated!

I'm going to use this post to share how I chose the corporate structure that I did.  First, in true legal fashion, I'm not a lawyer and this isn't legal advice.  Up to this point, I've chosen not to incorporate and simply operated the business as a "sole proprietor", an extension of myself.  This is a perfectly fine way to go if your business doesn't have much liability or if you don't plan on bringing in partners (co-founders, advisors or investors).  Well... I'm developing kids toys so liability will be in the cards and I do plan on bringing in partners.  The decision, then was whether to go with a Limited Liability Company "LLC" or a more traditional C/ S Corporation. 

First, I will discuss what I learned about LLC's.  Like C/S Corps, they remove risk from your personal self.  They are good for tax allocations since any losses or gains are passed directly to the owner (no double taxation).  On the surface, LLC's sound like they are "easier".  You go online, set-up your Articles of Incorporation and an Operating Agreement and file in your state (Ca for me so that's ~$800 bucks) and done!  This allows you to avoid the fees of filing in two states since most traditional corporations are in Delaware.  My tax advisor told me that LLC's are treated like a partnership.  At the end of the year, each member gets a K1 and income and losses are passed directly to the partners of the LLC.  Thing is, you can only recognize losses up to your basis.  So this is good early on assuming you have some income to write-off the losses against. 

If it's that easy, then why not become an LLC?  Lots of people do and many were telling me that was the way to go...  "if you have less than $50K in revenue, go with an LLC... you can always convert it to a Corporation later!"  In a way, what I learned is that LLC's are almost too flexible.  If you want to bring in co-founders, advisors, or investors you need to start building what looks like a traditional corporate structure.   So you hire a lawyer and they begin to define your structure... things like: manager vs member managed, classes of stock, board structure ownership controls, cash distribution, etc..

I'm building a "house" here and I want the foundation to be strong. For me, I want the ability to easily bring people into the business down the road.  I don't want to have to bake this "cake" twice.  With that in mind, I learned that an LLC may be more expensive in the long run.  If I were to set-up as an LLC and later on transition to a C-Corp, I'd need to hire a lawyer to "untangle" my Operating Agreement. 

I choose a traditional corporation route for a number of reasons.  VCs and angel investors tend to prefer a traditional corporation.  Why?  Because there are no surprises and the structure is already there and defined.  You file in Deleware which gives good protection.  You qualify in your own state.  So, yes, you need to file twice and that goes for your annual taxes too (which will add to your costs).  I filed as a Corporation but learned that I don't need to elect my C or S status until I do my taxes. 

An S Corp will allow me to avoid the "double taxation" and take advantage of that LLC pass-through on my individual return but it may prohibit me from taking advantage of something called the federal Qualified Small Business Stock tax law (QSBS).  The QSBS allows stockholders to avoid a portion of your capital gain - and in some instances ALL of your gains up to $10M on the sale of the business after five years.  So, if you sell your company for $10M and you are an LLC, you're going to get taxed on the base at the federal and state level.  With a C Corp, if I understood this correctly, you potentially avoid paying federal taxes (~28%!) on gains up to $10M!

So, there you have it.  In all honesty, I started off 100% in favor of an LLC.  At the end of my research and many conversations, I decided to go with a traditional corporate structure.  Many lawyers have start-up packages to incorporate for $2-3K and that's the route I took, but I'm told that Clerky.com has good documents for around $800 (includes 3rd party fees) provided you read everything carefully and do your annual due diligence.

If you want to go with an LLC, I know someone who used Incorporating Services Ltd. to be the registered agent and the filing on their own via https://incserv.com/.  Hope this is helpful and let me know if I am off in any way!

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