

Ask HN: Best legal structure for "different" type of startup - USNetizen

So I have a bit of a legal question (but I know the standard disclaimer - I do not expect people answering to offer official legal counsel or advice, etc. and I should speak with my attorney&#x2F;CPA - which I am next week but I&#x27;ve been getting a lot of conflicting messages from them).&lt;p&gt;So, long story short, I&#x27;m starting another company.  We work primarily with the federal government and other large enterprise agencies on contract.  I&#x27;ve been told by many SBA (Small Business Administration) counselors that I should forget completely about forming a corporation, and go directly to LLC due to their simplicity to operate.  However, I&#x27;ve been spooked because the company I last partnered with had issues raising funding using an LLC structure and other entities&#x2F;people seemed to see an LLC as less credible of a business structure.&lt;p&gt;That being said, I&#x27;m going to be working with a vendor (the government) where reputation and credibility is everything.  I&#x27;m leaning heavily towards a Delaware S Corp, which can then be converted to a C corp later on so I can offer tax-deductible benefits to employees (compared to an LLC where employee benefits are taxable to them).  The word &quot;corporation&quot; just sounds a lot more reputable to me and I assume clients in a risk-averse setting would see it the same.&lt;p&gt;Any thoughts on that?
======
redtexture
LLC vs. Corporation has nothing to do with credibility. That this is even
consideration is an indication of poor advice you have received so far. Nobody
that deals with the entity should care whether it is a corporation or an LLC
or Limited Partnership. There are giant multi-billion dollar LLCs, typically
divisions of some parent corporation. LLC simplicity makes it easy for LLCs to
be divisions of a parent corporation.

Why Delaware? Your own state's corporation laws are good enough unless you're
already gigantic or going public, or already are in Delaware, or someone is
specifically demanding it from you, which I strongly doubt. Plenty of
gigantic, or public companies do not incorporate in Delaware. Why do you need
to have a foreign-state incorporation rather than your own state? Make it
simple and less expensive, and use local-state incorporation and local lawyers
that are familiar with their own state's run-of the mill corporate laws.
Delaware is not that special.

A Limited Liability Company form of entity can be simple to operate, but they
are not flexible in having the ability to have multiple classes of investments
by others.

If you're the only person, or one of several individual partners, and capital
from other people is not a concern, then, sure, an LLC may work for you. Later
on, if you have a partner-founder depart, and want to issue a different
category of capital representation for him/her upon departure ("units" in LLC
speak), you can't, so LLCs are not so good at transitions either. Creating a
vesting process may also be cumbersome or not possible. Further, if you grow
and need capital, you'll end up becoming a C corporation, to be able to have
multiple classes of ownership shares.

C Corporations vs. S Corporations: these are elections that are made via a
filing with the US Internal Revenue Service. The S Corp has limitations on
what it may do and and still maintain its status as an S corp for tax
purposes, instead of the default C corporation status.

If you are seeking investments or venture funding: VCs and investors prefer C
corporations: the investor will not be taxed on net income as they would with
an S Corp. The C corp. can issue convertible preferred stock, which is typical
structure for a venture capital investment. S corporations can only issue one
class of stock, so that also is typically a deal stopper for investors.

Venture Capital funders don't like LLCs or S Corporations for the above
reasons, and will decline to participate, unless the entity converts to a C
corporation.

~~~
USNetizen
Well, here's the problem I found: LLCs are not treated consistently by all of
the states, and I will be doing business in more than one state (actually
having a physical presence in multiple states). Therefore, that is the reason
for a DE incorporation and my thoughts on using an S Corp (which I can at some
point check the box and change back to a C Corp). The "credibility" issue I
spoke of also applies not just to investors, but bankers have also been more
hesitant to loan to an LLC. I saw this with a previous LLC entity I was a
partner in.

Also, benefits paid to employees through an LLC are fully taxable income to
them, whereas with a Corp (either S or C) they are tax deductible (for
employees owning less than 2% of the company).

Furthermore, the stock ownership ("units") situation with LLCs is awkward at
best, like you said, so forget about incentive stock options and the like. I
understand the simplicity and have used the LLC structure before for other
reasons, but never for a multi-state entity.

Great input, thank you.

~~~
redtexture
Some questions to pursue with your advisers:

What are the tax issues upon dissolution/merger/conversion of entities from
one to the other, for the owners and the entity itself?

Is there an impediment to rapidly converting a Subchapter-S corp into to
C-corp - are there be any delays, fiscal year issues or alignments, or other
IRS filing or election issues and impediments, again for the entity and for
owners?

For foreign LLCs in terms of the "corporate veil" and limited liability, etc.,
set up in state Z, how does the foreign LLC get treated in other states of
interest, states A, B, C, and D compared to the foreign corporation set up in
state Z, operating in states A, B, C and D? Do those several states follow the
IRS-election for taxation of local-state activity?

What advantages / disadvantages for the LLC to elect to file with the IRS the
"filing as corporation" status, instead of the default sole
proprietorship/partnership status, or --yes you can elect this too--
"Subchapter-S"?

