We can help you set up and grow your startup. The scope of initial legal work that will be required to be done will generally be based upon your answers to the following questions:
A startup business is usually organized as a corporation or a limited liability company ("LLC"). The primary differences between a corporation and an LLC are as follows:
|Documents||Articles of Incorporation and Bylaws.||Articles of Organization and Operating Agreement.|
|Ownership||Stockholders own shares of stock.||Members own units of membership interest.|
|Management||Stockholders annually elect one or more directors. Directors (i) appoint officers of the corporation to manage the corporation and (ii) review and approve the actions of the officers.||Members may (but are not required to) elect one or more managers of the LLC. Members may either (i) directly manage the LLC, (ii) elect one or more managers to manage the LLC, or (iii) elect a Board of Managers that appoints one or more officers to manage the LLC.|
|Available Tax Treatment||C Corporation or S Corporation.||Disregarded Entity (for single member LLC), Partnership (for multiple member LLC), C Corporation or S Corporation.|
|Advantages||Investors usually prefer investing in shares of stock of a corporation, instead of investing in units of membership interest in an LLC. A corporation that chooses to be taxed as a C Corporation can issue preferred stock, convertible notes (convertible into preferred stock), simple agreements for future equity ("SAFE"), and keep it simple securities ("KISS"), which are the types of investments that are usually preferred by angel investors and venture capital firms.||Permits a business to have the benefits of pass-through partnership taxation without the stockholder restrictions of Subchapter S corporations. Permits owner-operators to manage a small business without the need to designate directors and officers. The flexibility in both tax treatment and formality of corporate governance makes an LLC a particularly good choice for family-owned businesses.|
The choice of income tax treatment is an important one. It should be carefully considered at the time of the organization of the startup. In general, the different federal income tax treatments available to businesses are as follows:
|Disregarded Entity||Pass-through tax treatment for a single member of LLC. This offers the advantages of not requiring the additional cost of preparing an annual IRS Form 1065 information return for the LLC.||A popular tax treatment for a single owner to operate a small businesse or manage a real estate investment property.|
|Partnership||Pass-through tax treatment for a multiple member LLC. Requires the annual preparation of an IRS Form 1065 informational tax return and Form K-1 to each member.||Has the advantage of permitting pass-through tax treatment, without having the ownership restrictions of a Subchapter S corporation.|
|S Corp||Pass-through tax treatment that is available for both corporations and LLCs. An entity with S corporation tax treatment is prohibited from having (i) more than 100 owners, (ii) more than one class of stock and (iii) owners who are nonresident aliens. In addition, the owners of an S corporation entity are generally limited to individuals, estates, certain types of trusts, and certain types of charitable organizations. Requires the filing by a corporation or LLC of an IRS Form 2553 to make the Subchapter S election. Requires the annual preparation of an IRS Form 1120S informational tax return and Form K-1 to each member or stockholder.||An LLC or corporation that has elected to be taxed as an S corporation is a popular structure for businesses that have a steady income of at least $50,000 a year and are owned by a small number of individual investors (and no entity investors). This tax election usually reduces the amount of social security taxes and medicare taxes paid by owner-employees, because distributions in excess of reasonable salary are not subject to payroll or self-employment taxes.|
|C Corp||This tax treatment results in corporate income tax being paid by the corporation or LLC (if the LLC elects to be taxed as a C corporation). Permits a corporation or LLC to grow without having to make distributions to its owners, as the owners are not subject to income tax on any undistributed income. An LLC electing C Corporation tax treatment must file an IRS Form 8832. Requires the annual preparation of an IRS Form 1120 tax return and Form 1099-DIV to each member or stockholder.||A Delaware corporation with C Corporation tax treatment is commonly used by (i) startup companies that require significant amounts of investment from venture capital firms to scale and (ii) publicly traded companies.|
In addition to choosing federal income tax treatment, you will need to set up professional accounting and payroll software for your business. You will need to (i) track the income and revenue for federal, state and local tax purposes, (ii) have payroll tax payments automatically withheld from payroll, and (iii) ensure overall tax compliance. If your business sells products or has offices in multiple states, your business will likely be subject to complex multi-state income tax return filing requirements.
The proposed terms of seed capital investment by outside investors will need to be carefully reviewed and negotiated. Certain provisions of convertible notes, seed series preferred stock, SAFE agreements, and KISS agreements can result in the significant dilution of ownership of the founders. The dilution would usually be triggered in the event of the issuance of a Series A Round of preferred stock or the sale of the business. It is important that the founders understand the effect of the provisions governing valuation caps, discount rates, liquidation preferences, pro rata rights, and note defaults.
This website provides general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to retain an attorney for advice on specific legal issues.