

How does one self fund a start up properly? - coglethorpe

I have a startup (I plan to set up as an S-Corp) and I'll want to add some of my personal funds to it as I earn side money, but I want to know the right way to go about it. If I pay myself with equity can I create additional shares, or do I have to transfer shares? If I consider it a loan to the corporation, do I need to specify terms of repayment?<p>I'm concerned about regulations regarding share sales as well.  I'm more concerned about the company making money in the long run than getting a loan repaid, so shared might be the right way to go, but I'm not sure.<p>Any websites that go over this for the self-funder, or person seeking a family and friends round?<p>Once things get going, I think I can manage it with it's own funds, but the first steps confuse me.<p>PS - I did submit this over the weekend, but the timing (around midnight on Saturday) may have prohibited responses.  Thanks.
======
timae
To answer your primary question, it doesn't matter that you "set aside" funds
to use for the business. As long as you can keep accurate records of what you
spend on your business, you'll be fine from an accounting/legal perspective.
As far as the legal structure of your company, you will probably want to
choose from either an S-Corp or an LLC because both allow you to avoid being
taxed twice. You mentioned you weren't seeking VC money, but even if you were,
that shouldn't influence your legal structure choice too much. Here are the
key differences:

1\. Self-employment taxes: A primary advantage of an S-Corp is that you can
avoid having to pay a portion of your self-employment taxes, if you plan on
taking more than "a normal salary" for yourself from the business. (I can
elaborate on this if you want.)

2\. Acquired/Investors: S-Corp's sometimes make it easier to be acquired or to
be invested in.

3\. Ease of operation: LLC is very easy to setup and maintain from an
administrative perspective. (I've always heard this, but admit I don't know
exactly how "hard" an S-Corp is, paperwork wise, or how "easy" an LLC is)

4\. Shareholder limit: S-Corp can only have 100 shareholders, LLC doesn't have
this limit.

5\. Profit distribution. S-Corp you must distribute profits in proportion to
equity ownership. LLC can distribute however it wants. (This one seems odd,
and although I know it to be a rule, I don't know the details of how its
carried out or enforced)

~~~
qaexl
Disclaimer: I'm not a lawyer, this is not legal advice. Most of this stuff
I've read through Nolo publications and other books and the rest I heard while
talking to people, so check with your own lawyer.

(3) S-Corp like a C-Corp requires you to act in ways demonstrating that the
corporation is a separate business entity, with its own agenda. If it can be
demonstrated in court that you are mixing your personal assets in with your
corp, then the court can decide that you no longer receive the liability
protection of the corporation. This means doing things such as having formal
meetings of the board of directors, keeping minutes, having resolutions for
the major business decisions (even if it is affirming the "actions of an
employee").

LLCs, on the other hand, from the last I've read of them, do not have the case
history saying how much formality is required. According to Nolo's book,
you're better off running it in the same kind of formality as a corporation,
just in case.

One thing LLCs can do well, is that they are meant to offer the same kinds of
liability protection as LLPs (limited liability partnerships), which can be
often stronger than a corporation. But it depends on how you set up the LLC's
operating agreement.

(4) There are more limits to shareholders than just 100 shareholders for an
S-Corp. The shareholders must be US Citizens, and a natural person. In other
words, if you have a VC fund or an Angel investing money in from their
business entity, you will have to convert the S-Corp to a C-Corp.

LLCs may not have the shareholder limits, but selling membership interests
over a certain number will trigger SEC regulations -- the same as shopping for
angel investors for a corp.

(5) Caveat: distributing profits from the LLC however way you want requires
some extra bookkeeping. You will have to track the tax basis of every single
LLC member, and track how it changes depending on money disbursed or put back
into the LLC. There should also be clauses documenting how this works in the
operating agreement. It is something you'll definitely want to ask your tax
lawyer or accountant about.

As far as I know, this feature was inherited from the LLP. It lets you defend
the assets held by the entity by starving out creditors -- you have to pay
taxes (assuming the LLC elected pass-through taxing instead of corp taxing) on
the profits regardless of how much is actually disbursed.

But to reiterate: I'm not a lawyer, this is not legal advice. Most of this
stuff I've read through Nolo publications and other books, so check with your
own lawyer.

------
iamelgringo
If I'm not mistaken, I really don't think that you want an S-corp for a
technology business. From my understanding, with an S-corp, all shareholders
must be US citizens: [http://www.allbusiness.com/business-planning/business-
struct...](http://www.allbusiness.com/business-planning/business-structures-
corporations/2516-2.html)

So, if you want to take VC funds, you're going to have to change to a C-corp.
There's also a lot of maintenance that has to be done as an S-corp or a
C-corp, that you wouldn't have to do if you incorporated an LLC or as a sole
proprietorship. If you're just starting off, this might be a little tough to
keep up with.

If it's just you, have you thought about setting up a sole proprietorship? You
pretty much get your "doing business as" paperwork filed with the county, pay
the business license fee and you're in business. After you do that, you can
set up a separate bank account with your businesses name, and run the business
off that bank account. Business taxes are handled on your own income tax. If
the business needs money, put it in the account, if your business makes money,
take it out. And, keep a decent set of books that separates your personal
finances from the businesses.

As for an LLC, the primary advantage that will give you over a sole
proprietorship is protection from getting sued. That is, if your company gets
sued, they can't go after your house and bank account. And, it's possible to
have multiple people as members of an LLC.

I've been mulling these same questions over, and my decision has been to work
as a sole proprietorship until I _have_ to incorporate. And, as far as I'm
concerned, I'm not going to have to incorporate until I need to offer shares
to employees or take outside investment.

~~~
tptacek
What everyone always tells me is, "forget about getting company structure
right before you take an A-round, because the VC's lawyers are going to re-do
everything anyways".

I'm not sure why, in what's effectively a sole proprietorship, you'd do
anything other than an LLC.

------
icey
Honestly, you should set aside $1500 or so, and go talk with a lawyer that
specializes in this sort of thing. It's risky to take advice from the internet
when we could not possibly know all of the intimate details of your situation.
A lawyer knows what questions to ask to help protect you and your money.

~~~
coglethorpe
I plan on talking with a lawyer and maybe an accountant about this as well.

~~~
tptacek
Don't get rolled. You can spend a lot more here than you want to at this stage
of your company.

 _[Edit]_ You have an outside shareholder and non-founding fulltime employees.
I retract my previous statement.

------
tom
As much as I respect the opinions and knowledge of much of the HN community,
this is really one of those instances where you need professional help. Don't
try to "do it yourself" this, it's too important and will have lasting effects
on the company, you, and your investors. Seriously, get a CPA or new biz
lawyer (local to your state - or where the biz will be legally located) and
talk to them. Get some help with the paperwork. Go to someone who can really
explain it all to you, as there is a lot and you might find your eyes glassing
over (I know mine did). I realize that you're cash poor, and don't want to
waste capital, but sometimes you gotta pay to play. A little cash outlay now
can save you a lot of heartache later.

Good luck!

EDIT: this is a great resource to go into any meetings with the folks
mentioned above knowing what you're talking about though. Knowledge is power!
:)

~~~
coglethorpe
Thanks for the advice. I do plan on speaking with some professionals (lawyer,
accountant, maybe therapist:-) ) about this as well. But HN is a great
starting point. I really do appreciate the help I'm getting here.

------
tstegart
Why the S-Corp route? LLC's are more popular for good reason. Either way, pick
up the Nolo series of books (or get them from the library). They are actually
quite good.
[http://www.nolo.com/resource.cfm/catID/9FA25870-14F1-4657-97...](http://www.nolo.com/resource.cfm/catID/9FA25870-14F1-4657-9778F19FB41FB93D/111/228/)

~~~
coglethorpe
I've considered LLC as well. Will that look ok for a national company? I guess
I fear a stigma of being seen as small if I have "LLC" at the end of the
company name. Is that silly? The S-Corp and LLC seem nearly the same for what
I want to do.

Thanks for the NoLo link. I'll probably pick one of those books up.

But more importantly, once the LLC/S-Corp is formed, how can one properly feed
it capital? And what about the money used to set up the corp? Can that be
private money? I guess it would have to be because the corp doesn't exist yet,
right?

~~~
tonystubblebine
Regarding the fear of being seen as small. This is probably a common fear and
it's certainly something I felt at the beginning. Our initial documentation
referred to "we" when it was really "I." However, it's good to get over this
and embrace your true size. It gives people a chance to be impressed with you.

For example when we launched we were competing directly with Ning which had an
ultra famous founder, 40+ million in funding and a two year head start. During
an interview with TechCrunch, the reviewer said, "Oh, you're a one-man Ning."

That sounds a lot better than, "you're a third-rate Ning." We've since gone
off into a vertical where we can actually be the leader but we're still
upfront about size. People give a us a lot more leeway and respect for it.

Also, when will people see your incorporation status? The only time people see
ours is when we bill them for services. There's no way to hide your size then.
It's not like you can present a bunch of fake personas. So your size is going
to come out in other ways and when it does you don't want to look like a
faker.

~~~
coglethorpe
That's an interesting thought. Our product line would be named differently
from our corporation, so I guess there shouldn't be a problem.

We would start with 4 shareholders and have two people working full time to
start out, so we could say "we" from the start. :-)

~~~
tptacek
Oh, see, that "4 shareholders and two full time people" thing? That's a pretty
important detail. =)

Do all the shareholders work for the company?

Are any of the FTE's NOT principals of the company?

~~~
coglethorpe
The first employees would be principals. None of the initial employees would
be principals, but we might need to hire if things go well.

~~~
tptacek
Put it this way: if _every_ employee will receive 1099 distributions instead
of a W2 paycheck, or if _no_ W2 employee will formally be given equity to
begin with, you're better off with an LLC.

If not, you were right to go for an S-Corp. It's just paperwork, and you're
not going to screw yourself over with it. We're converting right now without a
huge amount of legal pain.

------
iamdave
"If I pay myself with equity can I create additional shares"

If you don't mind the embezzlement/laundering/fraud charges.

[http://www.inc.com/resources/finance/articles/20040801/noVC....](http://www.inc.com/resources/finance/articles/20040801/noVC.html)

Fantastic article for what you're wanting to do, especially when it talks
about cash flow, though you'll be cutting it close there.

~~~
coglethorpe
Thanks, I'd like to avoid jail time if possible. :-)

I can still loan personal money to the corporation, right? I need an example
of how to go about that. Has anyone here done that? My plan was to seed the
company, then loan it some cash a few months in. I'm only talking about 10k
here.

The Inc. article is good, but it's short on the details I need. Anyone have
links to this sort of situation? I can imagine people with tech startups end
up in this situation all the time.

~~~
qaexl
You have to document it in board meeting, and spell out the terms of the
repayment. If you want to keep liability protection. From what I understand,
if the opposing lawyer can successfully argue that you appear to be
commingling funds and not operate as two seperate, distinct entities. How this
is determined is not so much by a clear set of rules so much as a set of
heuristics. They look at the formalities you've done, and other things such as
how much you have loaned versus how much the corp was capitalized as
(laibility-to-equity ratio) -- you'll want to ask your lawyer what is the best
way to go about loaning money to your company, how often and how much you can
do so.

------
shimonrura
Are you the only person involved in the company? If so, what's the reason you
want to incorporate? If not, or not for long, what are the current/expected
roles of your partners/investors/creditors/etc.?

I ask because I think it's common for hackers to get distracted by the myriad
of different options (it's a kind of engaging puzzle) and overbuild the
business side before there is a legitimate need.

~~~
coglethorpe
There will be four of us as shareholders, and possibly an outside investor.

------
augustus
I have an S-Corp for my technology startup and it works great.

The main thing regarding accounting is to create separate accounts for your
business.

Its best to have a business checking account and credit card account
exclusively for business.

If you pay for something from your personal account like your personal credit
card simply show it as a loan from your business to yourself.

You can keep records in this manner until you reach tax filing season (mar 15
deadline). At that time you can use a CPA accountant to file your taxes and he
should be able to assist you with your other questions.

Focus on keeping very accurate records and ethical in what is being used for
business and you should have no problems during tax time.

If you are taking on a loan in exchange for shares, I would definitely advice
you to get a lawyer to write out the terms and hopefully you can afford it
then.

------
epi0Bauqu
Why would you use equity? If you already own 100%, it won't change the equity
%s, so what's the point? And it will create headaches in accounting like
increasing the fair market value of your shares.

Just loan the corporation money on an ongoing basis as a loan, and then pay it
back to yourself over time. The only thing you have to worry about here is
that you need to pay yourself market rate interest or the IRS won't like it if
you get audited. But you don't need to make it complicated by paying interest
over time. Just add it up all at the end and pay yourself back in a lump sum.

~~~
tptacek
I strongly disagree with the first part of your argument and strongly agree
with the second part, for a totally different reason.

First: your shares _having_ a fair market value is a "win" condition. Before
steady cash flow, even after the (unlikely) VC A-round, they don't really, no
matter what you say. I wouldn't make practical decisions based on the eventual
number attached to shares.

Second: do the loan, don't buy more equity. What can happen is, a year from
now, that loan gave you more equity than your partners. The money seemed like
a big deal when you gave it it, but now that you're making $300,000 a month,
nobody cares. Now there's friction over the fairness of the equity purchase
you made. Not worth it.

------
dawie
[http://gigaom.com/2008/06/15/venture-capital-angels-or-
boots...](http://gigaom.com/2008/06/15/venture-capital-angels-or-bootstrap/)

[http://glinden.blogspot.com/2008/05/starting-findory-
funding...](http://glinden.blogspot.com/2008/05/starting-findory-funding.html)

------
michaelbuckbee
Amazon Web Services group is actually an LLC, and I'd like to think they know
what they are doing, though of course your situation may vary

[http://aws-portal.amazon.com/gp/aws/developer/terms-and-cond...](http://aws-
portal.amazon.com/gp/aws/developer/terms-and-conditions.html)

~~~
coglethorpe
I assume that's an LLC held by Amazon, Inc, which I assume is a C-Corp as it
is publicly held. They might have it set up as a smaller corporation to
protect the bigger corporation from liability.

------
bookhuddle
Hi.

I recommend you meet with a lawyer familiar with this type of stuff. If you
don't already know or have recommendations for a good lawyer, you can start by
visiting your local Small Business Administration or SCORE branch to speak
with people there for free. They can also give you some references.

~~~
tstegart
I second SCORE, I've heard nothing but good things.

------
coglethorpe
Wow. What a day. I have to thank all of you for sending this question to the
top! It overtook a Flash game and even battled off an iPhone reference for a
while.

I certainly ended the day smarter than I started it. I found the Atlanta SCORE
branch and scheduled an appointment with a counselor to start with. I'll get
an attorney involved if need be.

Of all my business ventures/attempts, I feel the best about this one. I'll
keep people posted... Thanks again and feel free to keep the comments and
karma coming. :-)

------
RobertL
You are worrying about the wrong things cog....

What you need to be worrying about is whether or not your product will attract
any customers.

Once you focus on that you should be able to relate to what Spartacus did and
said before he marched off into his last battle. After killing his horse in
front of a group of his soldiers he declared that if the battle is lost the
horse will not be needed anymore. If the battle is won than there will be a
bounty of Roman horses to choose from.

It's kind of the same way with startups. If your product attracts customers
and the money is flowing in just go to an accountant and have him work it all
out. If the product flops then it doesn't matter what the heck the rules are.
You don't get the play the game anyways.

~~~
coglethorpe
I am Spartacus. :-)

The product already attracts customers, but a team is needed to grow our
ability to make and sell the product. There is an actual physical product
here, but we need a better way to make and sell it.

------
Allocator2008
Check out www.delawareinc.com for info on how to incorporate as a delware
company to get a low tax bracket.

the way I read it, you can incorporate with 1500 shares at only a $60 a year
min. tax rate. This way you can keep your costs low, and not have the
limitations of an LLC.

~~~
tptacek
Delaware offers more protection if you get sued, but is not particularly tax-
advantaged, nor is it the easiest place to incorporate. There are favorable
tax implications to Nevada. Otherwise, as far as I can tell, picking a venue
to incorporate in is a lot like picking a domain registrar: go with what's
cheapest. Don't do NY --- you have to run an ad in the paper!

