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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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What’s The Best Corporate Structure For An Early Stage Company?

Comments (22)

I got the following question from a reader a week ago.

A project I’m involved with is aiming to go from a team of “4 founders with a great idea and a prototype” to a full fledged online service. I believe that even at an early stage, structuring ourselves to allow for growth/investment is critical. Naturally passion for our core mission, competence, and an ability to connect with the existing team are critical. Yet compensation (with an equity component) is a big part of the equation. I want people to have a sense of ownership and our current back of the envelope structure just isn’t suited at the moment for bringing people onto the team. To avoid reinventing the wheel, is there a “best practices” template for early stage companies with respect to structure/incorporation? What’s the smartest structure for an early stage company?

There are two logical choices (S-Corp or C-Corp) and a third one (LLC) that pops up occasionally.  The best choice depends on the financing path you are ultimately planning on going down.  Rather than define each of them in-depth, I’ve linked to the Wikipedia definitions which are very good.

S-Corp: If you are not going to raise any VC or angel money, an S-Corp is the best structure as it has all the tax benefits / flexibility of a partnership – specifically a single tax structure vs. the potential for double tax structure of a C-Corp – while retaining the liability protection of a C-Corp.

C-Corp: If you are going to raise VC or angel money, a C-Corp is the best (and often required) structure.  In a VC / angel backed company, you’ll almost always end up with multiple classes of stock, which are not permitted in an S-Corp.  Since a VC / angel backed company is expected to lose money for a while (that’s why you are taking the investment in the first place!) the double taxation issues will be deferred for a while, plus it’s unlikely you’ll be distributing money out of a VC / angel backed company when you become profitable.

LLC: Often an LLC (Limited Liability Company) will substitute for an S-Corp (it has similar dynamics) although it’s much harder to effectively grant equity (membership units in the case of an LLC vs. options in an S-Corp or C-Corp – most employees understand and have had experience with options but many don’t understand membership units.)  LLC’s work really well for companies with a limited number of owners; not so well when the ownership starts to be spread among multiple people.

Based on your question, it seems like you’ll ultimately want to raise money in which case a C-Corp is probably best for you.  An established lawyer who does corporate work with early stage / VC backed companies can set this up quickly, easily, and inexpensively for you – they are often the best source for the equivalent of a “best practices template” since this is routine work and requires simple, boilerplate documents and filings.

  • http://w-uh.com Ole Eichhorn

    IANAL, but, IMHO it isn’t a bad idea to start as an LLC, raise a seed round, and later convert to a C-Corp when you raise your first “real” round. This has a tax advantage in the first year(s) when you’re in development mode and have no revenue. I agree once you have outside capital a C-Corp is the way to go.

    Another big question for Mr. Feld, what’s the best state in which to incorporate?

  • http://stakeventures.com Pelle

    I have written about this in depth in my article legal structures for bootstrappers and unless you are going to look for outside investors immediately I think the LLC is your best bet.

    If you are bootstrapping and very early you can get away with a partnership, but you must write out some sort of partner ship agreement.

    S-Corp’s lock you out from bringing any non US persons on board. This may not be a problem for you, but imagine if you find this super hot coder in Rumania. He can’t receive any equity.

  • http://andrewbfife.blogspot.com Andrew Fife

    Yes hiring a corporate law firm is a very good idea. All of the big Silicon Valley firms will defer fees and introduce you to the VC’s they have relationships with… if they like your concept. Thus, you create a partner that is well connected in the VC community and has an interest in getting you funded in order to get their own fees paid. Selling the law firms on your concept is also a good litmus test because they set the bar lower than the VCs, so if the lawyers won’t defer fees, you probably aren’t ready to approach VCs. I’ve discussed this and linked to several firms that defer fees for startups here:

    http://andrewbfife.blogspot.com/2006/01/setting-vc-meetings-leveraging-your.html

    -Andrew

  • http://blog.softtechvc.com Jeff Clavier

    Will you address in a separate post which state should be used to incorporate a company, and whether Delaware, Nevada or the local state should be used ?
    Since it is a common request for VCs investing in Series A or Series B to request a Delaware re-incorporation, it might be useful to mention it.

    All the early stage companies I am involved in are California C-Corp’s.

  • http://www.startupfever.com/archives/2006/02/06/whats-the-best-corporate-structure-for-an-early-stage-company/ Startup Fever

    What’s the best corporate structure for an early stage company?

    Brad Feld answers the question What’s the best corporate structure for an early stage company?:
    There are two logical choices (S-Corp or C-Corp) and a third one (LLC) that pops up occasionally. The best choice depends on the financing path you…

  • http://www.business-opportunities.biz/2006/02/07/whats-the-best-corporate-structure-for-a-startup/ Business Opportunities Weblog

    What’s the Best Corporate Structure For a Startup

    Brad Feld the VC: C-Corp: If you are going to raise VC or angel money, a C-Corp is the best (and often required) structure.  In a VC / angel backed company, you’ll almost always end up with multiple classes of stock, which are not permitte…

  • Drake

    Brad, I am trying to help an entrepreneur set up a distributorship to take US made products–tools– to a large market in asia with a huge need. Start up costs are under $1million (5-10 angels and insiders), with proceeds going to pay for initial inventory take downs, field sales and support, and minimal opex.

    Question: what is the best equity structure for this company? We do not foresee a future liquidity event for R.O.C, but rather generation of cash consistent with a distributorship. Would appreciate any thoughts.

  • Gale

    I am a minority SH in an s-corp and the CEO of this family owned publishing company ( I am not family and own 10%). Recently majority owner (MO)has decided to sell significantly all the assets. I have indicated I would purchase certain assets by redeeming my shares so I can have an ongoing business, relaizing this will be a distribution and could create C-G for value above my basis.

    Maybe there is a simple way to do this. My “what if”. S-corp creates a LLC subsidiary and pushes down to it the assets I wish to carry on with, we then re-assign our ownership interests so I end up with 90% to 100% of the o/s in the LLC and family owners pick up a proportionate incease in the s-corp.

    Before I go to the attorney have you ever seen this type transaction?

    Thanks

  • Jim Johnson

    I and a JV partner are purchasing 30 separate properties for development. We were considering holding the properties in 4 separate LLC's, who;s units are owned by a Nevada Holdings Company. We want to know how we can have the profits of the holdings company flow into each of our own Family Foundations 47/53 split profits.

    • http://intensedebate.com/people/bfeld Brad Feld

      You will need to consult your lawyer on this one.

  • http://intensedebate.com/people/Cooper_Marcus Cooper_Marcus

    You don't need a C-Corp to take angel money – if it is in the form of convertible debt (which is should generally be!). Instead, stay as an S-corp, make sure the business looses as much money as you personally have invested, take the tax writeoff, then convert to a C-Corp if/when you are ready to raise an equity round.

  • http://intensedebate.com/people/bfeld Brad Feld

    Sure

  • emile castanet

    Can an LLC entity pay salary to its one or three owners as the S Corp. does?

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