Incorporating For Idiots
Today's topic brought to you by last year's faux pas
“In this world, nothing is certain except death and taxes.” ~ Benjamin Franklin
TL;DR— talk to a tax professional before making any major business structure decisions.
Last summer, one of my professional mentors sent me a link to a little product incubation program called Equifax Accelerate, an eponymous startup program co-sponsored by 1871 (which is to Chicago what Capital Factory is to Austin). My project has included an ID verification component since its inception, so it made sense to apply. There was just one little detail that nearly precluded me from doing so:
I needed to incorporate.
For those who don’t know, incorporation is the process of forming a business entity. It has major legal, tax, and organizational structure implications. A quick and dirty overview of the main forms*:
Partnerships (and sole-proprietorships)
Liability: General partners/sole proprietors are personally liable for all claims against the business entity (i.e. if someone sues your business, your personal assets are on the hook because you are an owner or partner). Limited partners are liable only up to the amount of investment.
Taxes: pass-through at the individual level. This means you can write off your out-of-pocket business expenses against your share of the profits.
Profit distribution: shared based on partnership agreement (or goes completely to the owner in the case of sole proprietorship).
Decision-making/control: unless otherwise agreed upon, partners each get an equal vote.
Limited Liability Corporations
Liability: as with partnerships, general members are all liable for all claims, while limited members are only liable up to the amount they’ve invested in the business (most U.S. states require at least two members to form).
Taxes: pass through.
Profit distribution: shared based on membership agreement.
Decision-making/control: management committee.
Subchapter S-Corporations
Liability: shareholders are liable up to the amount invested (minimum 100 shareholders to form).
Taxes: pass through.
Profit distribution: distributed as dividends to shareholders according to agreement/shareholder status.
Decision-making/control: board of directors appointed by the shareholders.
C-Corporations
Liability: shareholders are liable up to the amount invested, C-suite officers may be personally liable.
Taxes: tax-paying entity, taxed on corporate income.
Profit distribution: distributed as dividends to shareholders according to agreement/shareholder status.
Decision-making/control: board of directors appointed by the shareholders.
Every tech company I’ve ever worked for has been a C-corporation. There has been a board of directors (affectionately known as the BoD), stock shares distributed to early employees (on a vesting schedule, of course), and some degree of liability protection for founders and investors. So, being the characteristically decisive person that I am, I thought I’d skip ahead and incorporate as a C-corporation.
And that, folks, is how I may have just cost myself $2000 just to file schedule-C taxes on a business that made no money last year :)
My blunder became unavoidably clear after speaking with an old schoolmate of mine, a CPA who runs his own accounting firm. In my attempt to hedge against future complexity for my fledgling, bootstrapped idea, I inadvertently shortened the length of those very same bootstraps.
May you all learn from my mistake.
Catch you next week!
Jordan
Lately listens:
The Lunar Society: Marc Andreessen on A.I., Crypto, Elon, Regrets, Vulnerabilities, & Managerial Revolution (phenomenal episode— if you listen to anything this week, let this be it!)
Boys Club Pod: Urbit for Idiots (hat tip for the title inspo)
Recent reads:
Harrison Well’s series on blockchain literacy - this has been incredibly useful for getting more into the technical side of blockchain (vs staying at the level of interminable hype and buzzwords)
The Hard Thing About Hard Things by Ben Horowitz (of a16z repute). A front-lines look into some of the finer points of CEOing that they don’t teach in business school.
Weekly wisdom:
Remembering people’s names goes a long way towards building rapport.
Pro-tip: stop identifying as someone who is “terrible with names.”
(P.S. I’m sorry if I’ve forgotten your name, but I’m getting better at it!)
*Source: Allen, K. R. (2012). New Venture Creation (6th ed.). South-Western, Cengage Learning.