Categorized | For Entrepreneurs

Rules of Thumb: Matching the Right Business Entity to Your Business

Many folks are pointing to a coming wave of startups in 2009. My friend Nathan Kaiser of NPost writes on his blog that we can expect a wave of bootstrapped startups, given the limited capital available, the increase of soon-to-be entrepreneurs, and the ease with which a business can be started.

And I don’t disagree. It seems that more people are thinking “things are so bad anyways, why not give it a try.” And more power to them, right?

So what is step one? For many folks, one of your first steps to formalize a business is to form the business entity. In a prior post, I laid out some of the reasons why your choice of entity matters. The basic jist of the story is — pick the entity that fits your business and gives you the most long term flexibility.

Well, what choice should I make then?

Okay, so that bit about “flexibility” makes some sense, but then what choice should I make?

Joe Wallin, a fellow attorney from DWT, offers his take on why he generally encourages technology startups to consider S-Corporations over LLCs on his blog:

“I like S corporations better than limited liability companies as a choice of entity for technology startup companies for the following reasons.

1. S corporations can engage in tax free reorganizations, such as tax free stock swaps; in contrast, limited liability company owners have to pay tax on stock received in such transactions.

2. S corporations can grant traditional types of employee equity, like stock options, more easily.

3. S corporations can more easily convert to C corporations in the event of a venture financing or public offering.”

I happen to agree with Joe’s analysis for the most part — but I’m not willing to quite make it so black and white. Generally, I think it makes a great deal of sense to go the S Corporation route for folks considering building a high-technology business. But since there isn’t a one-size-fits-all approach to businesses, let’s assume things are a bit more nuanced in entity selection.

Rules of Thumb to Entity Selection

So, without further ado, here are my “Rules of Thumb” in entity selection:

First off, let’s assume you plan to keep it simple. While some startups will decide to create very complex structures with entities of various organizational forms located in various jurisdictions (such as setting up an entity in the Cayman Islands or splitting the company into a subsidiary to hold the intellectual property and license it to an

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1 Comments For This Post

  1. Tax Guru Says:

    I’ve been included in taxes for longer then I care to acknowledge, both on the personal side (all my employed life story!!) and from a legal standpoint since satisfying the bar and following up on tax law. I’ve supplied a lot of advice and redressed a lot of wrongs, and I must say that what you’ve posted makes perfect sense. Please continue the good work – the more people know the better they’ll be equipped to deal with the tax man, and that’s what it’s all about.

2 Trackbacks For This Post

  1. Just Passing-Through: Choosing between an LLC or S-Corp | My High Tech Startup Says:

    [...] should form an LLC or go the route of the S-Corporation. In a prior post, I wrote about general “Rules of Thumb” in picking a business entity. Several people asked for a bit more clarification on the [...]

  2. Just Passing-Through: Choosing between an LLC or S-Corp | Insights into Startups and Entrepreneurship - nPost Blog Says:

    [...] should form an LLC or go the route of the S-Corporation. In a prior post, I wrote about general

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