Corporate Entities

I was talking with a friend about startups and we began discussing the different types of corporate entities and which ones are most popular.  I found myself stumbling to answer his questions so I decided to read up and make sure I understood the different types of corporate structures at a 30,000 foot level.  Below are my brief notes.

You incorporate for 3 main reasons

  1. Investment- Even before we get to investing you may want to split the ownership of your company with a co-founder, incorporating allows you to do so.  If you want to bring in outside investors you must have a corporate entity that allows you to do so.This is an exchange of shares in your business for returns on capital.  
  2. Taxes- There are two types of corporate entities for tax purposes; flow through entities and tax paying entities.  Flow through corps. don’t pay taxes, they pass the income through to the owners of the business who then pay personal taxes.  Tax paying entities on the other hand, pay taxes at the corporate level, meaning the owners do not pay taxes on income earned by the business.
  3. Liability- You don’t want to put yourself at personal risk for the actions taken by your company.  Incorporating protects you from lawsuits, promises, and accounts payable.  This is probably the most important reason to incorporate.

The 3 main types of corporations are

  1. LLC- Most small businesses start out as an LLC.  It “limits the liability” of the owners of the business and the taxes are flow through.  The owners are typically referred to as members and investors as membership interests.
  2. S-Corporations- Are a middle ground between an LLC and C-Corp.  The taxes are still flow through, but the biggest drawback is that you can't do as much with the ownership structure .  They also only work if you have fewer than 100 shareholders.  
  3. C-Corporation- Most companies that a normal person would invest in are C-Corps (Apple, Google GE, etc).  As a business becomes bigger and the ownership structure more complex it is beneficial to move to a C-Corp.  They still provide the limited liability and they also become tax paying entities, meaning the founder no longer pays taxes on income earned by the business. Most VC’s will want to invest in a business that is a C-Corp for tax purposes as well as the benefits of having a more developed governance structure.