The formation equation

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So, I was going to write a big post on things to consider when deciding to form as an LLC or an S-Corp*. Only a few issues stood in my way:
1. I don’t really know what I’m talking about**.
2. There already is a great article and discussion going on at OnStartups.com. Check it out.
Here’s a few more random tips (sorry if they are confusing, I’m going to assume you know a little bit about both entities already. If not, Google and Wikipedia are your friends). As you’re reading the following, please keep in mind point #1 above.
Random formation tips:
One big question we had was how how easy it would be to get outside investors for an LLC. As it turns out, it’s quite easy for friends, family, and angels to invest in an LLC – in fact, some angels even prefer it to S-Corps or C-Corps. However, many VCs won’t invest in an LLC. The good news is it’s relatively easy change an LLC to an S-Corp or C-Corp when the time comes.
There is less documentation and overhead (and therefore legal fees) when running an LLC than when running a S-Corp. However, remember to still keep good records – they will still be important if you want to switch to an S-Corp or secure investors. Don’t think you can be totally sloppy just because you have an LLC.
If you’re going to IPO within a year or so, it’s probably better to just go ahead and form an S-Corp over the LLC, because you’ll probably have to change before the IPO anyway.
There is a potentially big tax benefit to an S-Corp over an LLC that has to do with salaries and self-employment taxes once your startup actually has revenue. It’s a little complicated, but you can read about it here. The good news? You can easily ask the IRS and your state to tax your LLC as an S-Corp and still get this benefit.
One reason you want an LLC or S-Corp is to shield yourself from liability (so people will sue your business instead of you personally). Apparently, LLCs are pretty good for this, but there has been less case law on this, so some lawyers consider it somewhat easier to “pierce the corporate veil” of the LLC than an S-Corp (this also varies by state). If you’re doing something that might make scary people angry, you might want the “stronger” entity.
Bottom line: Out of the five lawyers I’ve interviewed, all but one suggested an LLC over an S-Corp. But this was specifically for LLCs in Colorado. Check with several lawyers in your state before you make a decision.
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* For most startups, a C-Corp doesn’t make a lot of sense, since you get taxed twice and there is a lot of overhead. On the other side, Partnerships and Sole Proprietorships don’t offer good liability protection. So, we really only seriously considered S-Corps and LLCs.
** No, really. I’m not a lawyer, an accountant, or a tax geek, so don’t take this as gospel. Consult responsible professionals before doing anything.

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One Response to “The formation equation”

  1. Luke Pahler Says:

    The contractors at my work are S-Corps.

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