Incorporating

If you’re thinking about starting your own start-up, a key thing to keep in mind is to separate your personal assets from your start-up’s assets. Your objective is to protect your assets so if anything goes wrong, the bank or creditors can’t go after your personal assets like your home, car or personal savings. There are many different ways to protect yourself, but incorporating your business is the most popular choice. Deciding to incorporate doesn’t end there: incorporating also presents  many difference choices, such as S-corp, C-corp or LLC. Each option is briefly summarized below:

What exactly is a corporation?

A corporation is a legal entity usually created by permission of the state by filing appropriate paperwork with a specific state agency. Unlike a sole proprietorship or partnership, a corporation is considered separate and distinct from its owners; sort of like an artificial person. A corporation can enter into binding contracts, own property and borrow money.

C-Corp (also known as a General Corporation): this is the most commonly known corporation when people talk about corporations. Depending on which state the corporation is filed with, the fees and corporate tax rates can vary, plus some states have “corporation friendly” laws (such as Delaware). Most large companies are c-corps (think: Fortune 500). There is something known as “double taxation” where the corporation’s profits are taxed twice: first when the company makes a profit and reports it to the IRS, the second tax is when the profit is distributed either in the form as dividends or stock price appreciation (capital gains tax).

S-Corp: The IRS does not tax earnings of s-corp separately and the profit flows through like a partnership, so there’s no double taxation. The s-corp is limited to no more than 100 stockholders and each stockholder mush be a U.S. citizen or permanent resident of the United States. Ownership by foreigners or other corporation is not permitted.

Statutory Close (or Closed) Corporation: Can operate under simpler arrangements than c-corp, such as not having to elect a Board or hold annual stockholder’s meeting. The Closed Corp is limited to a certain number of stockholders depending the state (generally no more than 50). Not all states permit this corporation.

Limited Liability Company (LLC): Mixed attributes of a partnership and corporation. Since LLCs are neither corporations nor partnerships, their owners are called “members” and not stockholders or partners. Advantages of LLC include limited liability, taxed like a partnership (no double tax), simplicity in management and operation (not required to hold regular Board meetings and less reporting requirements), flexible ownership with any number of owners (unlike s-corp, an LLC can have foreign owners or other corporations). The only real disadvantage for a start-up is that certain states have different rules, but if you know which state you want to file with (usually California if you’re in Silicon Valley) then you’re good to go. Most informed start-ups tend to go with LLC due to lower incorporating fees and flexibility than the other options which leaves more time to focus on things like idea and product strategy instead of the boring paperwork.