Should I incorporate as an LLC, S-, or C-corp? Video Lecture | How to Start-Up your own Company (Video Course) - Entrepreneurship

hey everybody welcome to startup basics
it's your host Jason Calacanis you know
me as the host of this week in startups
and you know one of the things that we
like to do on this program is try to
help startups like it's kind of the
whole mission of the launch festival in
this week in startups and I get asked
the same questions over and over again
so I actually had lunch with my good
friend here Todd carpenter from Wilson
Sonsini WS gr and we've known each other
for a decade or so a long time working
with Steiner startups and Rachel you've
been at the firm for over a decade over
a decade as well Rachel profit and so we
just talked about okay what do we do why
we do a series where we answer like
every question so then we can just send
people to that link and at least get
them through the basic question so
that's what we're doing here at startup
basics we're like 10 questions out of 20
that we're going to do and so I asked
Rachel and Todd to come and answer one
that I have made so many mistakes on in
my career and gotten bad advice and now
that I'm 20 years into my career I think
I know how to do this right but this is
the question of what type of corporation
should I make should I make an LLC an S
corp or a C Corp and now there's even
this B Corp thing which I guess we could
get into too but let's just start with
if I'm starting a company in Silicon
Valley like it's a tech startup I'm not
talking about building a pizzeria you
know or consulting primitive I'm going
to start a tech company what should I do
S Corp C Corp or LLC easy short answer
is C Corp right Delaware C Corp
why and what is the difference between
these three types so that is the right
answer and twice in my career I did an
LLC and an S Corp because I had like
rank e dank attorney is like mom-and-pop
shops or telling me like oh do LLC do s
because you can get this savings or that
savings but what's the difference
between each one
well I would say to begin with that they
may have given you the right advice for
the particular company I think the the
point is that it's very company specific
so you want to set up the right entity
for the right corporation the right
company that you're working on for the
right business
the biggest difference if you look at
the LLC of
is the escort versus the c-corp the LLC
and the escort bar flow through tax
entities which means that you can avoid
a level of corporate tax escort and a
c-corp are largely the same other than
the tax treatment and a filing that you
need to make with the IRS to elect
affirmative ly to be an escort got it
and so if you're doing a mom-and-pop
shop that's when people tend to do these
LLC's or smaller companies like s quiz S
Corp stand for small or no it's just an
election under the tax code yeah Ashley
needs being small it doesn't actually
mean small cuz somebody told me it's
some way to mean small company I was
like really no it doesn't actually mean
that no and it doesn't have to be a
small business it could be it's just
there are restrictions on what types of
shareholders in the number of
shareholders that you can have in an S
corp so it's prohibitive to do that if
you're going to be a Silicon Valley
company yeah I mean every single company
in Silicon Valley is a secret right I'd
say for the most part I mean and we end
up dealing with a lot of founders that
come in and say I've been in S corp I'm
an LLC and I have a term sheet but one
of the conditions to getting funded is
in fact that we go through a conversion
process so we spend a lot of time
counseling folks who probably got advice
similar to yours yeah I want to be like
a normal look like everyone else C Corp
and what does that process like of like
actually changing it it's expensive
isn't it can be we're chatting about
this today we're going through a couple
of these with some clients right now I
mean they can be cost per head really
expensive sometimes really if you're
just running in a seed financing sort of
circumstance right you want to raise
fifty thousand hundred thousand bucks
like you pie don't want to spend
exorbitant of money converting yeah the
sooner you do it in your corporate
lifecycle the easier right there's less
contracts to think about less tax
consequences to evaluate maybe need less
of your accountants time to figure it
out
and they're not impossible but they can
be complicated and expensive now when
you want to shut one of these companies
down what about that process because
that's something I've had happen as an
angel investor where I was an angel
investor in an LLC or in an S corp or
even a C Corp and then nobody shuts it
down and I'm getting notices or somebody
says they did shut it down and I'm
getting notices why is shutting these
things down so hard and how does that
work well it's largely hard because
there if you do it properly there's a
lot of statutory procedure that you have
to go through to get it done and it's
large
designed to protect the people the
creditors of the company and the the
jurisdictions in which the companies do
business or are formed because there are
franchise taxes owed so you need to jump
through all those hoops of making sure
you paid all your taxes that you paid
all your creditors and so there is a
this whole process that you have to go
through it's not super challenging it's
just a lot of Hoops to jump through so
oftentimes because there's the the
shield of liability when these companies
are early-stage you'll see entrepreneurs
that basically just turn the lights off
and walk out the problem with that is
for years and years to follow you're
going to get these notices from the
state and if you're the only credible
guy that's left standing it may well
come to your address and that's really
frustrating for folks yeah that has been
frustrating for me like literally I had
some things where we sold companies to
AOL or whatever I'm still getting these
things and I'm like can we just shut
this down and then I wind up having to
pay a small fee or whatever to finally
shut them and just to stop getting the
mail let's talk about the big work
because I invested in one hand up is a
great company that we invested in that
is helping homeless people by building
profiles of them on the web where they
can basically communicate and what they
need in their life whether it's dentures
or a place to live and then get donators
and serial donators we give a little bit
each month it's really working
wonderfully but it's a B corporation and
this to me as an investor I had a really
hard time trying to figure out what this
is because I'm investing but it's not a
non-profit so they make a profit but
there's a benefit so what is this it's
interesting you say that you're probably
on the cutting edge of investors willing
to entertain this yeah are exactly that
reason so it's been around for a little
while yeah I think adoption rates have
been low for exactly that reason because
you know the principle is set out in
many jurisdictions to allow a public
benefit corporation which basically
means companies get to focus on
something in addition to just the bottom
line
right may not necessarily be just to
maximize profit we may also want to do
good in the community and for the
environment you know some other ulterior
hopefully better purpose repenting on
you talked to this could be the sort of
next wave of capitalism and wouldn't it
be wonderful if everyone sort of
dedicated to a greater grander purpose
to make this world in which we live
better but I think there's been a little
bit of question mark in investors Minds
regularly VCS because
it kind of blurs the question mark
what's my fiduciary duty and how am I
gonna relate to this company and how do
I think about this yeah but I think
again too true to yourself you're sort
of a trendsetter in fact you've already
invested in one yeah I'm not very
popular yet they're not popular but I
have to say amongst Generation Y and
young people they don't want to go to
work just for the bottom line it's not
very motivating for them it's very true
and so the way I got myself through it
was like if young people are going to go
to work to create something amazing and
this makes them want to come to work
more or be more entrepreneurial because
they feel like their company is aligned
with a goal and in hand ups case it's
getting people out of poverty and
getting people out of homelessness and
sustainably getting them out of there
then I guess you know I have to try a
beast so I've done one but what do you
think of this Todd are you saying it now
or discussions about it I get the
question every once in a while and I
think they're it's a really great idea
I when I think about it I feel like it's
very similar to some of the new
securities that we're seeing in the
market so whether it's that Y Combinator
safe or the convertible security and
things are really good ideas and I think
they've got a important role to play in
the ecosystem but if you're a first time
entrepreneur trying to get a company
funded you just don't want to have to
spend the cycles trying to explain
either a new security or a new type of
entity to the investor your core focus
really should be on your business and
getting funding and then getting back to
nose-down and focused on building your
business so I think that's the challenge
is that it is not that there's anything
inherently wrong with these things it's
just another hoop to jump through in a
difficulty with investors as you said
you had to get over it yourself and yeah
and you're a pretty liberal guy so I
think going to someone on Sand Hill and
and try to explain that and then have
them turn around and explain it to their
partnership it's not going to happen and
you just don't want that additional
question you know in five or ten years
maybe it'll be the standard the norm and
in you know there are these great
benefits to it and I think we all agree
that it would be something it'd be great
for capitalism and for society but I
think we've got a little bit to go
before their mainstream I think the good
news is
don't have to start there you can
convert in so if United to get exactly
so if you happen to get a lot of
credibility in that and the business is
going great and you want to give your
employees an extra incentive and get
your VC board on board with it you can
always convert like there's really
nothing I could not find at least in my
research that there was anything clearer
about like what that mission statement
means it's just that there is a mission
and episode that mission can change so
my question was like well what's the
difference if we did a seeker and just
said this is our mission and a B Corp
and this is our mission what's the
difference
I think it's creating an actual sort of
public statement that we're going to be
accountable right because depending on
the jurisdiction area and I believe
California is one of these if you elect
to be a public benefit corporation you
have to I think it's every other year
report to your constituencies how are
you doing
against your mission that you publicly
declared versus I'm a c-corp you can
make a statement and you may never talk
about it again and you have no
obligation to do so got it got it that's
very interesting and you know it's
interesting is the point you bring up
Todd of gosh you don't really want to
complicate things when you're dealing
with people who are very busy ie
venture capitalists and who let's face
it like they don't they have a system
for doing something and they have
signaling so when I did weblog zing
which was the second company ever did I
had an LLC because I was advised you
know by like a single practitioner to do
this and I had Yossi Vardi one of the
most famous investors in the world from
Israel and he's like Jason or rather
Jason that can't do this let's see I
have two taxes in the United States that
they can't do this and so I had to like
not have Yossi as an investor I lost
Josie has an investor which was great
for Mark Cuban who said I'll take
Yoshi's piece and Mark Cuban took it all
which was brilliant and got a 15 X
returned in one year which is why hey me
and Martin got along great but you know
if you make a billionaire a million
dollars it doesn't really matter but it
was fun to win together which is really
what he's about but gosh did I have that
exact experience now there's a really
good salient point which is you you have
to go with the flow yeah and if they see
something odd a lot of VCs they'll just
be like you know it's odd okay it's a
red flag let's just move on
kind of looking for reasons to ding
stuff I think well yeah and they're very
much pattern recognition focus because
they have to be I mean think about the
number of business plans that flow over
these folks desks and there needs to be
ways to sort through that so if there is
an added hurdle to get over it's just
more of a challenge like I said in the
beginning there are good reasons to
structure an entity as an LLC sure and a
lot of really smart private equity funds
require that it's that's who flipped on
its head but for VCS there are tax
reasons and their limited partners
prohibit them from doing it
yep even then if you're the right LLC
they can set up what's called a blocker
corporation and then it can work it's
just hard it's hard to convince them and
given the number of startups you're
competing with for capital these days I
just don't see a good reason to limit
your options and make it harder for
yourself yeah I am hundred percent agree
it matches my my painful experience now
what about when do you form the
corporation because I can tell you you
know through the hackathons and we have
these companies that magically start at
the hackathons a number of which I send
to Wilson Sonsini and you take very good
care of thank you we appreciate it well
you know it's actually really nice
because I get to send them to like the
best firm and they're like to you know
to people who made something week and
I'm like by the way here's like the best
firm that's you know not cheap and like
they're going to be the best and you
guys actually take very good care of it
we have the tiny office here now like in
so many it was a small office where you
do specialize in sort of doing which is
kind of a really smart move on your part
but when do you incorporate cuz now I
we've had this situation I should I say
us because we dealt with this four
people in a hackathon two people don't
want to continue to people do want to
make into a company they built something
there's some intellectual property a
gets built over 48 hours and then do you
incorporate before the hackathon after
the hackathon a month later when should
you decide to actually incorporate we're
just chatting about this over lunch and
I think you're going to get various
schools of thought but I think you
highlighted all the points right when
there's probably more than one of you
you need to figure out who owns what and
how that ownership is going to work
overtime wins are something created
right when you've got IP to protect its
best that that's in the company right
for the very reason you cited if it's
in the company and people want to part
ways you're going to have a battle to
resolve where does the where does the IP
go and let's remind ourselves the reason
we're talking about entity structure to
begin with is also from a liability
perspective right and the moment you
start to put yourself in a situation
where you could incur liability ie
you're going to sign a contract with
someone you're going to agree to pay
someone you're gonna you know sign a
lease put a product in the world zactly
right you want to on some sort of shield
between the rest of the world in
yourself personally so those are your
triggers intellectual property more than
one person working on it and the
possibility of personally being liable
for the fact that you put you know
whatever a ride-sharing company out
there where somebody gets you know
killed in an accident god forbid or gets
hit by a ride-sharing car you don't want
to have that personal life absolutely
yeah well I tell a lot of folks that
it's when you feel like you have
something important enough to protect
and I say reflect on what you're doing
and if you're making a decision to use
your resources whether it's your time or
your capital so if you're quitting your
job you feel pretty strongly about this
company yeah there's a pretty good you
should probably protect it you should
make sure that the IP is assigned to a
corporation and that you've got a
liability shield if you're willing to
pay several thousand dollars to
incorporate then that's the right time
to do it if it's just a weekend hobby
with you and a couple of buddies and
you're hacking on things and trying to
brainstorm and that's probably too early
you can save the money but once you
really start building a product you'd
feel strongly and you're committing some
resources to it it's not that expensive
and it's protective of everyone so I
think the earlier the better
yeah and nowadays there's a lot of tools
out there to get you you know we do
fixed fee formation packages you got
Turkey I used to be so expensive like
just thinking 10 20 years ago like just
the idea of going to a big firm and
doing it but it's kind of so much easier
absolutely no it's simpler um to just do
that well and then going back again
about entity structures in which you
would choose we can do a Delaware
c-corporation afternoon and it's very
cost effective and LLC is a contract
based a great situation so every one of
the LLC agreements is uniquely crafted
for that entity yes you can pull
something off the shelf but if
probably won't work perfectly so it's
much more expensive to set up that's an
LLC so if you want to do it quickly
cheaply again another reason to choose
the sequel alright listen rich and
profit John Carpenter Wilson Sonsini you
know the firm WS gr thanks so much for
just giving great honest simple advice
and listen I've made this mistake don't
be an idiot do it right and I what I
always tell people give it's worth doing
it's worth doing right that's not that's
the advice you give if you're if it's
worth doing like you're saying ty like
if you're hitting your job so if it's
worth doing do it right be buttoned up
and don't don't cause problems for
yourself in the future I will see you
next time
on startup basics thanks