The Obligatory “Corporation or LLC, DE or [Your State Here]” Post

Even though there is a ton of information out there about whether to form a corporation or an LLC and whether your home state or DE is better, the two single most asked questions I get are still “what entity should I form?” and “where should I form it?”

I think this happens for three reasons:  (1) many lawyers out there have covered this topic rather exhaustively, but their approach has been to explain the legal reasons,  not the business reasons of picking one form or state over another; (2) most of the information available on the internet or that you will hear from mentors and advisors is conflicting; and (3) before hiring me, prospective clients want to know my take on this issue.  I will attempt to address each of these in this post.

Many lawyers have covered this topic, perhaps too many.  And many have taken the legal approach to comparing and contrasting the differences between a corporation and an LLC.  I think these are all fine articles and fine ways of approaching this topic.  So, I won’t bore you with repeating what they have said.  Instead, I’d like to discuss a couple of business factors to consider when making your choice.

Regardless of what entity or state of formation you choose, your decision is neither final nor fatal.

The first is signaling.  What I mean by this is that your choice of entity provides signals to certain types of people you will come into contact with, specifically investors.  For example, if you choose to form a DE corporation, it may signal to a prospective investor that you know your stuff, or at least you think you do, and that you are serious about your startup.  By the way, note that I said “may signal” — for some investors this isn’t a signal, it’s noise (read Brad Feld’s post on this or my post on signal, noise and priorities to capture a few of the several perspectives on this issue).  Also, this is not to say that if you don’t pick a DE corporation you don’t know your stuff or you aren’t serious.  Confused yet?

The second is administrative overhead.  If you form your startup in a state other than your state of residence, you will still need to register your startup at home as a foreign entity.  After all, your home state wants your tax dollars too.  You will also have to prepare and file tax reports in both states and most likely find an accountant to help you since you will be too busy with your startup.  Add additional tax liability and accounting expense to your already stretched thin startup budget; do not collect $200 when you pass Go.

I was recently talking to a couple of entrepreneurs who were participating in the most recent graduating class of the Founder Institute in Seattle and they told me about all the mentors they posed this exact question to and all the different answers they got.  I am not pointing this out to tell you that the advice they received was wrong, but rather to highlight the fact that even very knowledgable and experienced people in the startup community have differing opinions about this issue.  The bottom line for you here is that there is no right answer.  The facts surrounding your specific startup will nudge you in one direction or another (notice I said “nudge”).  Regardless of what entity or state of formation you choose, your decision is neither final nor fatal.  You can always change your mind.  I will write more about this in a later post.

So, what’s my take on what you should choose?  Things are confusing and conflicting enough, so why not add to them, right?  I believe the choice of what entity to form and where to form it is a personal one and has to be consistent with the facts and circumstances surrounding your situation.  These include:

• How many founders are involved in your startup?
• How comfortable do you feel with long legal documents and do I like reading them?
• Will you be seeking outside investment?
• What sorts of signals do you want to send potential investors and do you even care?
• Will you be providing consultants and employees equity as an incentive to work with your startup?
• Do you mind explaining the differences between LLC and corporate equity?
• How much money have you set aside for the legal expenses of formation?
• Are you familiar with the personal, company and investor benefits of picking between entities and states?

There are many other questions you can ask but I can already see you glazing over.  So, I will spare you the exhaustive list and let you ponder these starter questions for now.  I recommend you grab a group of friends and your favorite accountant and/or attorney and sit down to discuss these more.  In the meantime, rest assured that there is no right answer, only the right answer for you.  And if you have already made your choice but think you made the wrong choice, don’t worry!  You can fix it.