We’re not here to bombard you with countless legal considerations. Here, you’ll find a practical approach based on your specific business stage and needs.
If you’re looking to expand your business, this article can help you understand what you need to grow and attract investment, from a legal viewpoint.
First off: Anything that you read in this article is NOT legal advice. We’re not recommending ANYTHING, it’s purely informational. Honestly, don’t even read on. THAT’S the level of “this is not legal advice” I’m talking about. Get your own lawyers and take your own risk!
No really. I don’t want you guys to blindly follow any advice on the internet (including the Eightception blog) and burn money (and legal blunders can cost you millions).
Read my stuff as a story and then think. You do you.
Another disclaimer:
Things differ in different countries. What I wrote here will be relevant for most regions like the US, Canada, EU, UK, India, Philippines, Australia, Malaysia, Indonesia, and other major countries. But I don’t know where you live and where you want to incorporate. In some countries, entities have different names, and the rules around taxation and shareholder limits may vary. So, do your own research.
So, you’re starting a business… Congrats, you brave soul! But before you start printing those “World’s Best CEO” mugs, wait a little. First things first: you need to figure out what kind of legal entity you’re going to be.
There are quite a few business entities to choose from – but fear not. It’s not that difficult to understand when described in a simple and digestible way:
Before we do that, I have some quick advice for you. Once again though, it’s NOT legal advice!
I keep repeating this because I can already see a ‘smart’ founder suing us for making a catastrophic mistake and blaming it on us.
Anyway…
If you’re alone – start small. Incorporating a company can be REALLY expensive. Closing a company and all its accounts and records – too. Just to create one, you’ll need to feed it with legal, finance, and tax professionals. Basically, you’ll burn through tons of money just to have a corporation.
Avoid these costs before you have a clear plan on how your business is going to generate revenue. You don’t necessarily have to start with a corporation right now, you know? You can always add more complexity later, as your business grows.
Just for this section, to make things clearer – imagine that the S in S-corporation stands for ‘small’ and the C in C-corporation stands for ‘chunky’. I know it’s silly to do this for such serious matters. But who cares?
The best thing about corporations for a startup founder such as yourself is that you can attract huge investments.
Having a Chunky corporation will help you attract the most investors and it will give you the most flexibility to grow. C-corporations are also the most complicated and expensive to run though, so weigh the pros and cons carefully! C-corps face “double taxation.” This means the corporation pays taxes on its profits, and then shareholders pay taxes again on any dividends they receive.
Another unique benefit of forming a C-corporation is the ability to issue different classes of stock. This can be very attractive to investors, as you can issue them a type of stock that they like more. Usually, it’s a stock that has a higher claim on assets and dividends than common stock.
(Smiles in venture capitalist)
If you have a smaller business and you don’t plan to grow outside of the US, the small corporation might be the best choice. S-corporations avoid double taxation and are limited to 100 shareholders.
Pass-through taxation can be simple and great, but the IRS does scrutinize S corporations closely due to potential tax loopholes, so you have to be careful and do your due diligence. In summary, if you want to keep things simple and you don’t plan to have more than 100 shareholders, give this a thought.
Dear small-business owner, I have one important note before we move on to the next section:
Don’t try to follow every single piece of advice you encounter. Of course, information about legal structures is crucial – but don’t stress over it to the point you feel paralyzed.
Choosing a legal structure is something every business owner has to figure out… and every business owner does figure it out. It can get overwhelming, but you’ll get through it.
SPACs (Special Purpose Acquisition Companies) are used by corporations and investors aiming to take companies public. A SPAC is set up as a “shell” corporation with the sole purpose of merging with a private company and getting it listed on a stock exchange. If you own a larger business and you want to take your company public quickly, SPACs can be a great idea.
However, make sure to do your due diligence, as the regulators have cooled the SPAC boom down by introducing way more scrutiny.
While a SPAC is designed to take a company public, an SPV is more like a versatile tool for managing financial risks and isolating certain projects. An SPV is a separate legal entity created by a holding company for one specific purpose – like investing in real estate, launching a new product, or even managing startup investments.
Imagine an SPV as a fortress around your business venture. Each SPV has its own assets, liabilities, and legal standing. So, if one SPV (let’s call it “SPV 1”) invests in real estate and things go south (say, a legal issue arises), only SPV 1’s assets are at risk. The other SPVs don’t get dragged down.
So, if you’re a founder who’s looking to expand while making sure to stay safe – we recommend you look into SPVs.
Yes, having a solid business plan that seems lucrative is extremely important when attracting investors… but it’s not all about the pitch.
Get into the minds of investors and ask yourself: “How can I minimize risk for them?”
You can also do it from a legal viewpoint! For example, having a corporation minimizes risk, as they can collect dividends from their stocks instead of being directly liable for the company’s debts.
Or… as I mentioned already – if you set up an SPV, people will be able to invest without exposing themselves to the risks of your other operations. If they want to invest in your “startup investment” SPV, but not the “real estate” SPV, they can do so.
If your main goal is to attract investment, always think about making it a no-brainer for them. You don’t want to end up as a zombie company (companies that collected significant investments and then failed to generate profits, hence the zombie name).
One last piece of advice regarding investors: Don’t completely trust them to do all the legal work. Naturally, they protect their interest, and you should protect yours. For example, when analyzing the regulations in the geographical area you operate in, don’t completely rely on investors. Hire your own lawyers too!
Here’s a quick overview of what we talked about in this article – so you can quickly understand corporations, their uses, and benefits:
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