James Johnson’s law practice focuses on early-stage startups and small businesses. Although his practice is industry-agnostic, Johnson has worked with mobile/web app companies, consumer products companies, education companies and medical tech companies. Many of his clients, though not all, are usually younger entrepreneurs in college, grad school or recently graduated. About half of his clients are, or will be, working on their businesses full-time, while the other half work on them part-time to generate extra income or until the business takes off, justifying a switch to full-time work within their chosen business. Johnson shares his expertise on how to structure a company.
(Photo courtesy of James Johnson)
How should I structure my company?
The answer for how a founder or group of founders should structure a company is not an easy one. It involves considering a number of factors related to how the ownership is to be split, how the company is to be managed and what the goals of the company are. Typically, small businesses that are intended to be run by a couple of owners, are organized as limited liability companies. LLCs are preferable for small businesses with a few owners because they are less formal and more flexible than corporations. LLCs are also flexible in how they can be taxed, as LLCs are by default taxed as a sole proprietorship, if it only has one owner, or as a partnership, if it has multiple owners, or a LLC can elect to be taxed as a corporation either under Subchapter C, the standard corporate ‘double taxation’, or Subchapter S corporate pass-through taxation.
If a company is intended to have a complex ownership structure, with multiple classes of equity for groups such as investors or employees, corporations are the preferred structure. Although LLCs are inherently flexible, in my experience, as the equity or management structure of an LLC gets more complex, the complexity of the organizational documents increases even faster. The law governing LLCs is also less well-developed than corporations, so it can be difficult to predict how regulatory agencies or courts would treat or interpret very complex LLC structures. Because corporations are better suited for complexity, investors tend to prefer that companies they invest in be structured as such.
Founders also have to consider what state in which to organize their company. Although Delaware and Nevada are popularly touted as states to form a company, unless a company will be seeking private investment, there is little benefit to forming one’s company in Delaware or Nevada for the sake of forming in Delaware or Nevada. It is easier and cheaper simply to form in the state where the business will be located. Forming in Delaware and Nevada, but running the business in another state, will require filing and fees not only in Delaware and Nevada, but will likely also require registering as a foreign corporation in the state where the company is operated.
This article was written by Robin D. Everson of Examiner.com for CBS Small Business Pulse.