Kathryn McCall, a partner at Seidman Bancroft with over two decades advising startups, walks through choosing a business entity. She covers four types, why corporations are most common for startups, and key factors like formation costs, tax consequences, and liability. She also flags recurring mistakes she sees even among seasoned CEOs: wrong entity choice, underestimating tax and liability, and poor governance.
Chapters
Thank you. Okay. Hi. Hi. So as you heard, my name is Catherine McCall. I am a partner with the law firm of Seidman Bancroft in San Francisco. My primary focus is corporate and securities work, and I have been working with startups, entrepreneurs, and venture capitalists since 1999. So yeah, hopefully most of you were born by then. So yeah, it's been a while. I have seen the dot-com boom and bust. I have seen many other little booms and busts since then. I've seen the shift in what startups were to what they are today. You know, they were focused more on hardware and then of course the internet boom came out. And then now to where we are today. It's been a very interesting journey and hopefully I can share some of my knowledge with you. I'm going to talk to you about 2 topics today. One is choosing the right entity for success. And most of you are going to be corporations, but I thought I would throw in a couple of other different business entities because you might not quite be ready to be a corporation yet or you might have unintentionally created a different type of business entity. So, I'll cover 4 different types of business entities and also the most popular for startups, which is your corporation. And then I think we have time for a little break and then the second topic I'm going to talk to you about is the typical mistakes that I see startups make. I've been doing this since 1999, which is what, 17 years now? And I see these mistakes over and over and I even see them from very, very seasoned CEOs. I mean, I've got guys coming in to me, serial entrepreneurs, or working on their 4th company, and they'll make one of these mistakes. I'm like, really, guys? Like, how long have you been working with me? What is going on? So they're common. They're easy to make. So hopefully I can steer you a little bit down the path so that you guys don't make these. Or at least if you do, you know it and you can fix it or know what you need to fix. So, Tim, So, getting right into it. So, the things to consider when you are choosing your business entity. You want to think about cost. How much is it going to cost to set up that entity? You want to think about what are your future plans? What are you going to do with your business? And then you want to think about funding. How are you going to fund that business? Are you looking for outside investors? Are you going to bootstrap it, friends and family? And then you also want to think about the tax implications. Different entities have different tax implications. In some types of entities, all of the earnings from that entity will flow under your personal income tax return. Others, the entity gets taxed, and then you don't get taxed until you get a distribution from that entity. You also want to think about liability. What's What sorts of issues, problems, or liability could your corporation or startup have, and how do you need to protect your personal assets and yourself from those? And then lastly, think about record keeping. How good are you at keeping records? Are you going to have people that can help you keep records? Some types of business entities are more record intense, require a little bit more documentation, a little more upkeep. A little more governance than other types. Let's see if this works. Yes. Nope, I went backwards. There we go. All right. So things to ask. So what type of business do you want to have? Is it going to be a microenterprise or maybe a home-based business? Is it going to be a family-owned business? Do you want to hire other employees or is it just going to be you? And you can also think about this. I know you guys are all thinking startups. Of course, we're going to have hundreds of employees and we're going to take over the world. But think about where you are right now. Are you still in your home? Is it just going to be you? Is it going to be you and your brother, you and your friends? Are you going to hire other employees? How is the business going to look in the beginning? And then also think about your personal assets. What do you need to protect? What's your personal risk level? If something goes wrong with that business, do you want to be personally protected? Do you want to make sure that nobody can come after your personal assets if something goes wrong with the business? Or are you a little more, you know what, it'll be okay and I trust that everything's going to work out? Can you get insurance to protect yourself against any problems? And what are the other— what are the possible liabilities? I mean, you've got different liabilities that you would have in a brick-and-mortar store than you would if you're strictly online. Brick-and-mortar store, you got to think about theft, somebody walking in, slipping, falling, those sorts of issues. Something going wrong with the building, plumbing, electrical, those sorts of things that are different than if you're just operating out of your home or if you're existing solely in the cloud or solely online. How will the business be funded? Is it going to be a personal line of credit? Are you going to bootstrap it? Are you looking to friends and family? Are you looking for outside investors? Because different types of funding sources look for different types of entities. Your friends and family might be willing to give you, the person, the check. An outside investor wants to invest in a corporation. So, let's— Things to think about. And how do you want to handle your taxes? Because if you're— hopefully your startup has some earnings, although in the beginning a lot of times it's more losses. But do you want those— that income and loss to pass through the entity to your personal income tax return? Do you want it to stay with the corporation? How do you want to handle that? If the income from your startup flows through to your personal income tax, will put you in a higher tax bracket. So those are things that you want to start thinking about when you're forming your entity. Now, cost. What are the legal fees to prepare the documents to form the entity? Some entities don't require any documentation at all. Others require filings with the Secretary of State. So those are the fees you have to think about. Then cost to maintain the entity. Some types of entities like an LLC or a corporation, you have yearly filing fees. Other types of entities, you don't have those fees. Think about, you know, what sort of legal advice are you going to need? To protect yourself from liability in some sort of entities— some entities, you need to maintain what we call certain formalities and do certain things. So how much is it going to cost you to get the legal advice that you need To make sure you're doing the right things so that you get that protection. Don't worry, we're going to talk about all of this. And then drafting of documents and then again the ever-popular taxes. And then what are your future plans for this entity? Are you going to take on more partners, more investors? Are you going to take on employees? Do you want to maintain control of that entity? Or are you going to take on outside investors where you're going to lose a little bit of control in exchange for getting the money that would help your business grow faster? What are your expansion plans? Are you always going to be operating out of the garage? Are you going to hire employees or are you going to take over the world? What are your future plans? Think about it. Map it out. I saw somebody smile. Take over the world? Yeah. Yeah.
