Before diving much deeper into funding, I thought it might be worth doing a post on structure of the company from a tax/income point of view. We'll get into internal personnel organization in later posts.
One of the first things you'll be faced with in starting your business is whether you should be a sole proprietor, partnership, LLC, S-Corp or C-Corp.
As a sole proprietor, your company is an extension of you, yourself. From an income point of view, all income goes directly to you and all losses come out of your pocket. In addition, you have direct responsibility for anything that you, your company, or your employees do that may make you liable to legal or debt actions. You can protect yourself from this liability by securing insurance for your business.
Generally a sole proprietorship is suited for a small self-funded business that will face limited exposure in terms of potential legal liability. There is no basic structure to allow investment into the company so you'd need to make private arrangements (typically loans) for any funding you can't provide.
Partnerships are similar to sole proprietorships except that the ownership, profits and expenses are divided among the partners according to their percentage of ownership. While partnerships work in some cases, I've seen many situations where a partner isn't carrying his or her load, where a partner wants to leave the company, where a spouse decided to intervene, and many more problems that in my mind make this a challenging structure for your business. If I were looking for a partner-like structure, I'd probably pick an LLC instead.
An LLC or Limited Liability Company has the structure of a partnership where the income and expense pass through to the owners like a sole proprietorship or partnership. Its primary advantage is that it adds a layer of liability protection. Its simpler to form than a corporation and doesn't require the formality of a corporation (e.g. board and shareholder meetings).
In our country for good or bad (e.g. campaign contributions), a corporation is considered to be an individual and thus, many liabilities go to the corporation itself and don't pass through to the owner(s). This is called the 'Corporate Veil'. Many expenses like healthcare, retirement monies, equipment and software purchases, inventory, etc. can be assigned to the corporation even if they benefit the owners.
For an entrepreneur looking for investment and for potential exit, a corporation may be the best choice. Note that forming a corporation has costs and in states like California, there is often a minimum tax payment after the first year, even if the company has no income.
The simplest corporation is an S Corporation. An S Corp is like a sole proprietorship except that you have some protection of the 'corporate veil'. You are limited in the number and types of shareholders you can have but you can provide stock in exchange for investment. All income passes to the shareholders. This may be the best choice if your goal is to take as much money out of the company as possible but to have the protection of a corporation.
One big advantage of an S Corp is in Social Security Taxes. I expect that at some point, this loophole will be closed, but under current law, shareholder distributions (profits) are not subject to Social Security Taxes. That is, the corporation could pay you a salary of say $70,000 per year, and if you had profits of $30,000 in a given year, you'd pay no Social Security tax on that $30,000. You do need to draw a 'reasonable' salary. That is you can't take a $1 salary and pay yourself $99,999 in profits. Note that all profits in an S Corp are assumed to be distributions to you and are taxed accordingly.
S Corps are limited somewhat in the number of shareholders and if you're thinking of going public, you'll need a C corporation. In addition, because of the flow-through of income and expense, there is less protection for the shareholders than in a C corporation. And, in a C corporation, you have more flexibility in terms of how you recognize revenue and expense. C corps are much better if you think you're going to do reinvestment in your company as opposed to taking all the profits every year. Profits in a C Corp may be doubly taxed if you try to touch them. You'd need to declare a dividend after paying corporate tax on the profit, then those receiving the dividends would also be taxed on the dividends.
Bottom line, if you're looking for outside investment, are thinking you might want to go public someday, want as much protection as possible and want to invest in the growth of the company, minimizing those taxes, go for a C corporation.
In all cases, you'll need a business license, even if you decide to operate the business out of your home. For a sole proprietorship or partnership, you'll also need to file a fictitious name statement. You don't need to do
that for a corporation because a corporation is a legal entity itself and has a name granted by the state.
One of the first things you'll be faced with in starting your business is whether you should be a sole proprietor, partnership, LLC, S-Corp or C-Corp.
As a sole proprietor, your company is an extension of you, yourself. From an income point of view, all income goes directly to you and all losses come out of your pocket. In addition, you have direct responsibility for anything that you, your company, or your employees do that may make you liable to legal or debt actions. You can protect yourself from this liability by securing insurance for your business.
Generally a sole proprietorship is suited for a small self-funded business that will face limited exposure in terms of potential legal liability. There is no basic structure to allow investment into the company so you'd need to make private arrangements (typically loans) for any funding you can't provide.
Partnerships are similar to sole proprietorships except that the ownership, profits and expenses are divided among the partners according to their percentage of ownership. While partnerships work in some cases, I've seen many situations where a partner isn't carrying his or her load, where a partner wants to leave the company, where a spouse decided to intervene, and many more problems that in my mind make this a challenging structure for your business. If I were looking for a partner-like structure, I'd probably pick an LLC instead.
An LLC or Limited Liability Company has the structure of a partnership where the income and expense pass through to the owners like a sole proprietorship or partnership. Its primary advantage is that it adds a layer of liability protection. Its simpler to form than a corporation and doesn't require the formality of a corporation (e.g. board and shareholder meetings).
In our country for good or bad (e.g. campaign contributions), a corporation is considered to be an individual and thus, many liabilities go to the corporation itself and don't pass through to the owner(s). This is called the 'Corporate Veil'. Many expenses like healthcare, retirement monies, equipment and software purchases, inventory, etc. can be assigned to the corporation even if they benefit the owners.
For an entrepreneur looking for investment and for potential exit, a corporation may be the best choice. Note that forming a corporation has costs and in states like California, there is often a minimum tax payment after the first year, even if the company has no income.
The simplest corporation is an S Corporation. An S Corp is like a sole proprietorship except that you have some protection of the 'corporate veil'. You are limited in the number and types of shareholders you can have but you can provide stock in exchange for investment. All income passes to the shareholders. This may be the best choice if your goal is to take as much money out of the company as possible but to have the protection of a corporation.
One big advantage of an S Corp is in Social Security Taxes. I expect that at some point, this loophole will be closed, but under current law, shareholder distributions (profits) are not subject to Social Security Taxes. That is, the corporation could pay you a salary of say $70,000 per year, and if you had profits of $30,000 in a given year, you'd pay no Social Security tax on that $30,000. You do need to draw a 'reasonable' salary. That is you can't take a $1 salary and pay yourself $99,999 in profits. Note that all profits in an S Corp are assumed to be distributions to you and are taxed accordingly.
S Corps are limited somewhat in the number of shareholders and if you're thinking of going public, you'll need a C corporation. In addition, because of the flow-through of income and expense, there is less protection for the shareholders than in a C corporation. And, in a C corporation, you have more flexibility in terms of how you recognize revenue and expense. C corps are much better if you think you're going to do reinvestment in your company as opposed to taking all the profits every year. Profits in a C Corp may be doubly taxed if you try to touch them. You'd need to declare a dividend after paying corporate tax on the profit, then those receiving the dividends would also be taxed on the dividends.
Bottom line, if you're looking for outside investment, are thinking you might want to go public someday, want as much protection as possible and want to invest in the growth of the company, minimizing those taxes, go for a C corporation.
In all cases, you'll need a business license, even if you decide to operate the business out of your home. For a sole proprietorship or partnership, you'll also need to file a fictitious name statement. You don't need to do
that for a corporation because a corporation is a legal entity itself and has a name granted by the state.
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