

Ask HN: How to structure an LLC for giving out equity - raheemm

I have a project (content site - http://itleaderstoday.com) I've been working on for about a year and its time to recruit (writers, marketers). However I can only offer equity.<p>So I thought about forming an LLC but not sure what would be the next step? How would I offer a percentage of ownership, what is the right percentage to offer a head writer, editor, etc; how do I offer stake without dilution, etc.<p>Right now, I pay writers a minimal amount per article. But I could get better writers with a more ownership type of incentive.
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edash
I recently did some fundraising and employee grants with an LLC and it was
more complicated than you'd think...

You should make sure your grants have a "distribution hurdle." If you don't
have a distribution hurdle, the options you're granting may be taxed as income
immediately upon receipt. This would leave your employees with a big tax bill.

You should put everyone on a reasonable vesting schedule. With vesting,
everyone is in it for the long-term and the shares given directly correlate to
the work performed and the value provided to the company.

You should talk with your employees and agree in advance to the work being
performed in exchange for shares granted during the vesting period. There is
no clean way to include this in the operating agreement or grant notice, so
communication is crucial. If either party is ever dissatisfied with their side
of the arrangement, however, they can always leave. And if you've set up
vesting appropriately, both sides should still be happy even if you don't
reach the end of the vesting period.

Why would you want to prevent employee grants from diluting in the future? It
breaks the alignment of incentives. If everyone dilutes equally, everyone has
the same incentives regarding future investments. An investment would only be
accepted if everyone thought the trade-off of money for equity was worth it
based on the current valuation.

But if you DO want to prevent dilution, it's a fairly straight-forward clause
you can add to the operating agreement. I'd suggest setting a ceiling or an
expiry date for the dilution prevention clause. This ensures that if things
change dramatically in the future, you won't be handicapped by your non-
diluted employee grants.

Disclaimer: I'm not a lawyer. This is for entertainment purposes only. Don't
sue me etc.

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asanwal
As Terretta mentions, you'll be offering "membership interests" and as far as
I remember from our experience with an LLC, you don't offer shares but
"units".

You'll have to detail unit interests in your operating agreements and set up
unit subscription agreements with your employees. Most of it is akin to what
you'd do with a C-corp but the terminology is a bit different.

One note: If you're contemplating raising outside investment in the future
from angels or VCs, a C-corp may be preferable as it appears to be their
preferred structure (not a hard and fast rule but a preference). I've heard
LLC to C corp "conversions" can be less than pleasant.

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18pfsmt
Any of the VC names you read about on this site or others like it will not
fund you without transitioning to a C-Corp.

As far as converting from an LLC is concerned, you just form a Delaware
C-Corp, which acquires the LLC.

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whittwuli
I would also suggest using an S-Corp instead of an LLC. It gives you the same
benefits and flexibility as an LLC with pass thru profits and such but you can
create shares more easily.

As far as paying your writers with equity, I like this approach defined in
this article: [http://www.readwriteweb.com/start/2009/05/building-your-
team...](http://www.readwriteweb.com/start/2009/05/building-your-team-pre-
financing.php)

It talks about forming a contract where you will pay them double there hourly
rate which they can then buy equity with it once the business gets it's first
valuation.

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keith_erskine
Agreed - Granting or selling shares is much more straightforward than an LLC.
Plus converting an LLC to an S or C-Corp takes a lot of billable hours.

So - find a lawyer local to you, and have him set up the S-Corp in your state.
Don't worry about it being in Delaware. Making that change later, or even
going to a C-corp is easy (for a lawyer)

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mpclark
Don't know about the LLC/S-Corp end of things, but on the 'how should I split
it?' stuff I think Joel Spolsky's response here makes a _lot_ of sense:

[http://answers.onstartups.com/questions/6949/forming-a-
new-s...](http://answers.onstartups.com/questions/6949/forming-a-new-software-
startup-how-do-i-allocate-ownership-fairly/23326#23326)

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Terretta
These percentages of ownership are called "membership interests", and they can
be for operating or non-operating partners or investors. Both people and
corporations can be members in an LLC.

Many of the biggest companies use LLCs for their advantages. Check the return
label on your next package from Amazon.

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jasonkolb
Yeah, and you have to detail how all of that works in your operating agreement
and spend thousands of dollars to do so. An S-corp takes care of everything
for you due to the huge body of law around corporate share treatment, you get
all of that free of charge with a corp.

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Terretta
That "body of law" is also a box. It significantly constrains your options.

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veyron
The issue with LLC ownership is that it becomes much harder to kick out
someone later on [or to transfer ownership interests], especially if you are
onboarding some unsavory characters.

As far as ownership is concerned, with an LLC the payments do not have to be
proportional to the ownership percentage. This is one way in which the LLC
differs from the S-corp, because the S-corp requires that payouts are
proportional to ownership stake. Hence, a small ownership stake in an LLC can
mean diddly squat.

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darklighter3
I would guess that the pass-through taxation of an LLC would complicate
granting equity to employees.

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jasonkolb
LLC's are ripoffs. Use an S-Corp instead. They are far cheaper and easier, are
FAR more flexible, and you get the same tax benefits.

LLC's are for people who don't know any better (and this includes myself,
several times now in the past, having only been fully educated in this area
fairly recently).

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jeffepp
In Michigan you can form a LLC for $50. It's super simple.

EDIT: I am also an attorney, but have never practiced. In most cases a LLC is
the best way to incorporate your startup. (Unless, you know you are getting
funding ASAP)

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jasonkolb
Ok, how much is the yearly filing fee? How are profits taxed? How do you
distribute ownership interest?

Super simple to set up, complex as hell to use.

