Entrepreneur Program Blog / To Incorporate or Not to Incorporate by Valerie Leikina, Founder of Faux Paus
Sandbox Accelerator Finalist Valerie Leikina blogs about incorporation. This is based from her experience in our accelerator “Setting up your Company” session with accountant expert Scott McKenzie of Moody, Famiglietti & Andronico (MFA) and lawyer expert Daniel Sieck of McLane Law.
Choosing an entity…seemingly an easy task? Decide on a strategy, file some paperwork, get your ducks in a row…make some $$ right? Perhaps in neverneverland!
The gritty reality of the legalities associated with business formation has the potential to leave a budding entrepreneur just short of drowning in a sea of dependent considerations. LLC’s can be taxed as S corporations, S corporations evade double taxation but can get hit hard with unemployment tax…members can be managers but managers need not be members…how to keep your head above water?
Our approach was to vet considerations by evaluating applicability to our short term vs long term goals. In the short term, it seems counterintuitive to be taxed at the same rate as hot shot companies bursting with cash at the seams. However, the main concern for FauxPas is the ability to protect our scalability and long term growth. Growth requires capital and when the time comes that we are in a position to fundraise… scrambling for legal assistance to create an umbrella company that can accept investment $$$ for the right distribution of equity… is not a position we want to be in.
So what’s more pertinent? Which concern more realistically and more substantially affects business? How to decide what takes the cake?
In order to decide we asked ourselves the following questions:
- At what point we will be ready to seek outside funding?
- What type of investment entities do we plan on approaching: Angel, VC, bank, FFF (friends, family, fools)?
- Can we realistically get in front of our target investment audience within the proposed time span?
- Will we have taxable income in the interim?
- What does our ideal management structure look like?
- How do we expect our management structure to evolve with growth and potential cash influx?
Now let’s weigh the options:
Pros: ease of formation, less record keeping/formalities, single taxation, limited liability (protection of personal assets), flexibility of management structure etc,
Cons: limited life, looming headache of incorporating down the road, potential to inhibit ability to obtain funding
Pros: limited liability, tax shelter, independent life from shareholders
Cons: corporate formalities, shareholder compensation requires, inability to take institutional investors, limited to 100 shareholder, limited to one class of equity, higher unemployment tax, looming headache of creating an umbrella company
Pros: limited liability, perpetual existence, unlimited growth potential, unlimited number of shareholders, ability to exchange equity for institutional investment
Cons: Double taxation, corporate formalities, must create bylaws to form, tough to dissolve
With all that said…it’s obvious that at the end of the day we will have to incorporate…eventually… to protect the long term vision. The question becomes, do we want to deal with the headache of corporate formalities now…or later? I think for most companies the answer will probably be an “obviously later”. If we were planning on hitting up uncle Johnny for the initial seed $$ we need to build out a minimum viable product, I would say the answer would be “later” for FauxPas as well. However, the nature of our business model requires a non-trivial amount of start up capital… and we definitely do not want to make any choices that will inhibit our ability to attract a strategic investor right away.
In this specific circumstance…I think it will be worth going balls to wall and making a B line right for C Corp. If we have to take a tax hit on our pre-money revenue…so be it: small sacrifice for a greater vision.
-Valerie Leikina, Sandbox Finalist & Founder of Faux Pas