Should I set up LLC or INC?
We have quite a lot of questions here at Incparadise about people should start LLC, Corp C or Corp S. Since this questions very complex it is very difficult to answer the question. While answering this question, it doesn’t really tell you which entity you should set up. I will try to give you a few hints when and how you should make a decision.
Limited Liability Company
LLCs are structured as managers and members. Managers are responsible for the company decision and members are the owners.
LLC provides legal asset protection.
Taxation: You pay taxes at the personal level so whatever you earn, it will be regarded as personal taxation.
Investors will always prefer that you set up a C corporation because you can issue your investors’ common shares or more likely preferred shares.
You can not distribute shares to employees. Meaning, LLCs do not give you an option to set up Employees Stock Options (ESO).
Since the company doesn’t have shares, you would have to mention in the Articles of Association the percentage of the ownership of each member.
LLCs are mostly much cheaper to maintain with regard to yearly fees. For example, if you set up a company in Nevada or in Wyoming, you will likely pay very little.
LLCs are very good for owning properties or small businesses.
S Corporation
You convert your C corporation to S corporation. An S corporation functions as an LLC legal entity from the tax point of view.
An S corporation provides legal asset protection.
Before you convert C corp to S corp, make sure that you understand the consequences. The issue might be that the conversion might be costly and you might realize that it was a wrong decision in which case, you will have to convert the S corp back to C corp.
C Corporation
This is my favorite entity. And I would say that 99% of all Silicon Valley startups go for C corp preferably incorporated in Delaware (Why Delaware? This is for another topic).
C corporations provide legal asset protection.
You have directors and shareholders. Directors are the responsible bodies for company decisions. They pass any important resolution into effect.
Shareholders are the owners of the company and elect the directors.
C Corporations have several features which can be used for any startup.
The company has 2 types of shares: Preferred and Common.
- Preferred shares are mostly issued to Investors (They have many preferred rights over common shares)
- Common shares are mostly issued to founders. The founders also create the Employees Stock Options (ESO). If you issue ESO, you would need to set up the striking price, vesting schedule and year cliff.
When you are issuing new shares or looking for investors, there are also many new terms you should study:
- KISS (Keep It Simple Security) – released by 500 Startups (open source document). It is a debt interest. The key is to keep the fees low so you can use it whenever you feel you don’t need a lawyer
- SAFE (Simple Agreement for Future Equity) – it is similar to KISS (open source document). Released by Y-Combinator. It is not a debt and has no maturity date or interest. Investors give a money today for the future equity.
- Warrant – It is like an option. However, there are differences; it is issued by the company.
- Convertible Notes – short-term debt issued by a company to the investor. Convertible notes are usually converted into equity.
Incparadise has also many questions; if any US-based bank opens a bank account remotely for startups, the answer is no. All banks require you to come to the US and open the bank account in person. There might be some exceptions such as Silicon Valley Bank but your business case must be strictly high-tech as SVB is based in the Bay Area; it is quite obvious who the typical clients are, mostly high-tech and IT startups. When I was talking to one of the Bank representatives, I was told they also offer financing and have great connections to Venture Capital.