Unless another form of business entity would be more advantageous than a corporation, such as a general partnership, limited partnership, limited liability company, for the type of business of the startup, the incorporators of a startup have many important factors to consider prior to incorporation. Some of the factors to consider are generally described below.
Generally, the incorporation of a startup will be in the state in which most of the business of the startup will be conducted. Each state has its own corporate laws and state tax laws that may make it more advantageous for the startup to incorporate in a particular state depending on the startup’s type of business. For example, Delaware’s corporate laws generally favor management and the majority shareholders over minority shareholders whereas other states do not. Another example, Delaware Courts are more reluctant to allow the piercing of the corporate veil than New York Courts (piercing the corporate veil means that a shareholder’s personal assets can be reached to satisfy a judgment against the corporation). The incorporators may choose states like California or New York because there may be more availability of venture capitalist financing. The above are just a few examples of the multitude of factors that need to be considered prior to incorporation in a particular state.
Prior to incorporation, the incorporators must determine whether the start-up should be taxed as a S Corporation or a C Corporation.
S Corporation. To qualify as an S Corporation, the corporation must be a domestic corporation, the shareholders may only be individuals, certain trusts, and estates, it may not have more than 100 shareholders, have only one class of stock, among other requirements. Selection of this type of entity taxation allows the shareholders to avoid double taxation and allows the shareholders to take deductions for losses that may be incurred by the startup. After incorporation and the election to be taxed as an S Corporation, if the needs of the startup dictate the S Corporation can be converted to a C Corporation.
C Corporation. If the startup will be seeking venture capital financing, a C Corporation may be the appropriate form of entity to choose. One reason that potential venture capitalist investors may prefer this form of entity taxation is that they can receive their returns on their investments taxed at a lower capital gains tax rate rather than as distributions which may be taxed at higher ordinary income tax rates. There may also be additional tax advantages of selecting a C Corporation depending on the type of business of the startup.
Careful consideration should be given to the name of the startup prior to incorporation. The name of the startup should be distinctive and conveys the purpose of the business or the nature of its services or products. Once the state of incorporation is selected, the availability of the name in that state and any other states in which the startup intends to qualify to do business as a foreign corporation should be searched. A federal trademark search should be conducted prior to the incorporation of the startup to avoid any potential future trademark infringement claims. If the startup will only be operating in a certain state or states and there is no federal trademark registration of the name, a search of the particular state or state's trademark registrations should be searched to avoid any infringement claims. For example, in California, the state trademarks are registered with the Secretary of State and may be searched on its website. The incorporators should also check the availability of the name as a domain name if it is necessary for the business of the startup.
There are many more nontax and tax factors to be considered by the incorporators of a startup, so it is imperative to seek the advice of an incorporation attorney and/or other tax professional prior to incorporation.
The information contained in this article is for general informational purposes only. Any information in this article should not be relied on as legal advice or a direct solicitation of clients. You should consult an attorney regarding advice for your individual situation. The content of the article may not be up to date as there may be recent changes or developments in laws, ordinances, statutes, regulations, court opinions, rulings, or verdicts. Nothing in this article should be taken as creating an attorney-client relationship. Legal advice is only provided to clients that have executed a written retainer agreement with an attorney.
The founder of Mazis Law Group, Dmitry Mazisyuk, has 20 years of experience representing businesses of various sizes in different segments of the economy. Dmitry provides legal and business consulting services to determine the best approaches to protect his client’s businesses. He is committed to finding practical and cost-effective solutions to complex legal matters.