Lead Thinking The Business of Software Development

Creating a Startup – Choosing a Company Type

This is the first in a series of articles I’m writing on company formation. The series will be from the perspective of a non-resident alien to the US and will encompass:

1. Choosing a Company Type
2. Incorporating a LLC
3. Obtaining an LLC EIN
4. Obtaining an LLC Bank Account
5. Obtaining a Merchant Account

When you go through the company incorporation process, you need to decide what type of company you need.

All have their pros and cons, and what type is best for you really depends on your short to medium term objectives.

I’ve outlined the types below, and the general scenarios in which they’d be applicable.

LLC

Has been called the Ruby on Rails of company types – light and flexible. Youtube, for example, is a LLC.

The main benefits of an LLC are:

• Pass through taxation
• Less formalities
• Lower state taxes (yearly franchise tax)

The pass through taxation means you only pay income tax, and you don’t get double taxation (as in the case of a C Corp).

LLCs are run by their managing Members, and unlike C/S Corps there aren’t shares, but rather membership interests.

The caveat to an LLC is that a VC is less likely to invest – since when do they risk getting an income tax called UBTI (unrelated business tax income) which is frowned upon.

C Corp

Most of the big companies out there are C Corps. If they’re publicly traded then they definitely are.

C Corps are subject to corporation tax, and therefore suffer from double taxation (once at the corporate level, and once on a personal level).

There a lot of formalities regarding the incorporation and running of C Corps, such as bylaws and shareholder meetings – some of which you can avoid with LLCs.

S Corp

A corporation that’s elected Subchapter S status in the eyes of the IRS. In plain English that means you have pass-through taxation, like an LLC, but the following restrictions apply:

• No foreign shareholders
• Shareholders are limited to 100
• Shareholders can’t be companies

S Corps can provide tax advantages over LLCs, but you need to weight that up against the extra administrative costs.

It’s unlikely that you’ll be able to get investment as an S Corp (certainly not VC investment) – however switching from an S Corp to a C Corp is a matter of checking a box in your tax forms – no lawyers needed. Moving from an LLC to a C Corp, on the other hand, is a much more tricky process.

---

Now, which one should you choose? Obviously that depends on your circumstances and if/when you’re getting investment.

However, for non-residents I generally would suggest a LLC. It’s a lightweight structure, with pass through taxation, that doesn’t have any of the S Corp restrictions. It’ll get out of your way, meaning you can spend more time building your startup, and less time dealing with administration.

In the next post I’ll explain how to actually get incorporated, and the signing of the Articles of Organization.

Additionally, I’ll be ‘open sourcing’ our Articles or Organization - making them freely available to everyone.