“Should I form a corporation or an LLC?” That is the question I hear the most, although it comes in different varieties. Corporation vs. LLC may be the initial question, although there are way more options available and that can confuse other startup founders.
It is not surprising that startup founders struggle with what type of entity to form and the state to choose for registering the new business. There is a dizzying array of options available to startups. Corporations (C, S and B), limited liability companies (LLCs), limited partnerships (LPs), limited liability partnerships (LLPs), benefit corporations, nonprofit corporations, nonprofit associations, low-profit limited liability companies (L3Cs), social purpose corporations (SPCs).
Unless the startup is doing something very unique, such as forming a venture capital fund, in which case they’d elect to be a limited partnership with a limited liability company as the general partner, the decisions are actually fairly straight forward. So, the corporation vs. llc question is usually the simple and correct one.
The decision turns on what the startup expects its future to look like. Assuming the entity is being formed for an operating startup (as opposed to an entity formed purely to hold assets, such as real estate), the key questions will be:
1) Do you expect to raise venture capital/institutional investment?
2) Will you have partners?
3) Will you operations give rise to much risk (liability as to third parties)?
4) How many employees do you foresee having in a couple years and will you want to give them equity in the company?
Beyond the entity type decision, startups need to decide where to register the new business. What state should they file the certificate/articles of incorporation in?
Approximately 80% of the startups I work with decide to form a corporation in Delaware or an LLC in their home state. Most of this decision depends on whether or not the startup expects to raise venture capital or other institution investment. VCs and other institutional investors generally want their portfolio companies to be registered/formed in Delaware. About 15% decide to form a corporation in their home state. The remaining 5% are unique decisions, like the startup investment (venture capital) fund.
By the way, Facebook started as a Florida LLC. You won’t likely make a huge mistake here, so don’t kill yourself over the decision. You can change things later. It’s possible, if you change the type of entity, that you will have tax issues, although probably not if you do that in the near future or, if you do, they won’t be enormous.
The maximum flexibility, planning for the future, is achieved by forming a Delaware corporation. However, if you aren’t actually based (your operations, primary office) in Delaware that will increase your filing and ongoing maintenance costs – something like $1,000 upfront and $500/year compared to just being in your home state. That can vary, but it’s not a massive difference. So, some startups default to Delaware just to be safe.
Determining what entity to form for your startup and where to register the entity is not simple, given the overwhelming number of options, but it does not have to be that difficult of a decision.