By Robert A. Adelson
Mass High Tech, March 28, 2012
If you are launching a new business, it is wise to create a separate legal entity under which you conduct the affairs of your new business. Creation and use of this entity, either a corporation or LLC, can protect you against liability, enhance your credibility in the marketplace and provide an ability to offer equity to employees and investors.
For that entity, you have a number of choices –
• Do you want a corporation or LLC?
• Do you create an S corporation or a C corporation?
• Do you form or incorporate in Delaware of Massachusetts?
Each has its own strengths and weaknesses which I mention further below. LLCs, S Corporations and C corporations, whether Massachusetts or Delaware are all limited liability entity but have differences in tax treatment, costs, complexities and other business attributes.
LLC – Limited Liability Company
The LLC can offer the greatest simplicity if you are a “single member” LLC – i.e. you don’t have a partner or anyone else own any equity besides yourself. In that case you don’t need a separate employer ID or need to file a separate tax return. The entity can be reported on your Schedule C. However, if you will have other owners, you will need an operating agreement which can be quite complex and is not recommended unless your LLC will own real estate or other tax sheltered assets in which case despite the complexity, it offers tax advantages.
The S Corporation will require its own employer ID and tax return but can offer the advantage to single owners of allowing you to allocate part of your income to a distribution which avoids self employment tax of 15.3 percent, which is taxed on all LLC income. It’s worth discussing with your accountant whether the tax savings from an S corporation justifies in your mind the added work of the S corporation. The corporation is also recommended if you will be using your corporation to try to recruit people to your company and offering equity. Offering stock or options in an S corporation is much more straight forward then offering member units in an LLC.
The C Corporation is best when you know you will be seeking outside investment from angels or venture capital investors. The S Corporation unlike the C Corporation cannot offer preferred stock, cannot accept partnership shareholder or non-resident alien shareholders, all of which are desired when outside investors are brought in. The Corporation is also more liquid and accepted as an investment vehicle than an LLC for business investments and thus preferred.
Delaware vs. Massachusetts
For those who are starting small and bootstrapping their startup, a Massachusetts LLC or Corporation is the best as the simplest and cheapest means to a limited liability entity for your business. If you incorporate in Delaware (or Nevada), you will need to hire and pay for a resident agent there as well as incorporation and annual costs there, and still have to file to do business as a foreign corporation or LLC in Massachusetts which in total will cost more and offer greater complexity. However, if you will be seeking angel or VC investment, such investors prefer Delaware laws which prefer majority shareholders and investors over employee investors and will likely insist on that state or incorporation for your C corporation.
With each of these entities, it is wise to hire an experienced business and tax attorney, skilled in this area to both guide you through the process and draft your business organization documents. There are many pitfalls in the road to forming a business entity and it is unwise to try to do this on your own or to take your focus away from marketing, sales, product, team and business operations your business needs to succeed.
(c) 2012 by Robert A. Adelson
Robert A. Adelson, Esq.
Engel & Schultz, LLP
265 Franklin Street, Suite 1801
Boston, MA 02110
617-951-9980 x 205