This content was created by Tim Draper. This content was uploaded by Tim Draper. This is a YouTube video titled "Corporate Entity Rights | LegalZoom CTO Eddie Hartman" (posted Aug 13, 2018). The excerpt is from a presentation/Q&A led by the presenter (Speaker A, likely Eddie Hartman) with an audience member (Speaker B). The speaker gives an instructional explanation of corporate entity concepts: the benefits of incorporation and limited liability, differences between LLC/LLP and corporations, stock issuance, C-corporation vs S-corporation tax treatment (double taxation vs pass-through), why investors/VCs prefer C-corps, and the limits/exceptions to personal liability for corporate actors. The tone and context are educational/legal/business-focused.
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a lot of protection. Let's talk about that protection for a second. So it's the best deal going. And this is not me talking. This is just, if you think about it, the government wants to encourage innovation. Can you do anything else? So whether you're in Singapore, whether you're in the UK, whether you're somewhere else in the EU, the idea of incorporation was a revolution when they came up with it, which several hundred years ago now. Think about it. If you invest in IBM, if you invest in Tesla, if you invest in— I don't know, who do you want to invest in? Who do you want to invest in?
Dananos.
I don't know Dananos, but okay, if you want to invest in Dananos. They can do terrible things. I mean, horrible things, really shockingly bad things, and you are not liable. How is this possible? You know, you, you, let's say you invest in Monsanto. I would not advise doing that, but let's say you invest in Monsanto, and let's say you give them $1 million, and then Monsanto takes your $1 million and they poison a bunch of people. You're not responsible at all.
Not at all.
You're just a shareholder. You've got no responsibility. None. Interestingly, the people running the corporation, 9 times out of 10, also have no responsibility. See why that's important. So the corporation can do horrible things, but the people running the corporation are scot-free. And then finally, the corporation itself has— what can we say? It has no body. It can't be put in jail. It has no lifespan. It goes on forever. And yet we've, in America at least, and in the UK and other places, we've given corporations a lot of rights. So for example, free speech. We've decided in the United States that you cannot limit the free speech of a corporation. It's almost as if the corporation is a person that gains a bunch of rights, even though a corporation cannot be put in jail, has no lifespan, and has no sort of corporeal presence. So this may strike you as good. This may strike you as bad. But here's the point. For about $100, you get all of this. You can absolve yourself of any personal liability. You can absolve your investors of any personal liability. All you need to do is incorporate. or set up a company. All you need to do, in other words, is entity formation. Hey. What's the difference between both? So if I, for example, incorporate in comparison to forming a company, what's the difference? Right. So again, let's talk about your sort of 3 big types. An LLC is not a corporation, it's a partnership. Okay. So it's people coming together. You may see law firms described as an LLP or an LLC. The L and the L don't stand for ladies love, it stands stands for limited liability. So literally, it's those first 2 points. If you set up an LLC or if you set up an LLP, which you wouldn't do because you're not a— I assume you're not a lawyer or an accountant— you're absolved of liability even though you don't have what's technically called a corporation. Now, what becomes a corporation? You issue stock. So an LLC has memberships. They've got members.
Yeah.
An incorporation, on the other hand, issue stock. Now you may say, wait a second, but I'm just starting off, I wouldn't issue stock. You're probably thinking of a stock exchange, like a publicly floated stock. That's not necessary. You can have a small company, as small as you like, it still has stock.
Why?
Because you want to encourage investors to come in, or employees. You want to grant employees options. These options may not be publicly traded, they may be illiquid, meaning, hey, it's a piece of paper, I can't get any cash for it. But nevertheless, the corporation itself has issued shares. Now generally, when you create a corporation, if you don't change it, it's going to be taxed twice. First, it's going to be taxed on its profits. So this is the corporate tax rate. And then whatever is left, you know, to the, to the owners, maybe you distribute it out, that will be taxed a second time. You might say, well, that's a terrible deal. No, it's not a great deal. So if you have an LLC or if you elect to be taxed as an S corporation, which has very severe limitations if you're not a US citizen. But if you elect to be taxed as an S corporation, then all of the money flows through to the owners, and they're only taxed as their personal income. So then income tax applies. Let's do that again. Company comes in, makes $100, and it's a C corporation. C like Charlie, right? It's a corporation— by the way, by default again, it's going to be a C corporation if you elect to create a corporation, right? $100 flows in, you're taxed at the corporate tax rate. Based on that, depending upon the polity that you're in, where you are, you then retain a certain amount of money. That money is then used, that profit is then used to be distributed in dividends or salaries or anything else, and that's taxed a second time. So when you get it, then you pay dividend tax or personal income tax. If you contrast that with an LLC or with an S corporation, That entire $100 is not taxed at the corporate level. It all flows through and then is taxed at the personal income level. Okay, so those are the 2 different forms. So you might say, why would anyone want to do a C corporation? C corporations are essentially more grown-up. An S corporation or an LLC, they've got some real limitations on them. If you do get investors, if DFJ comes and invests in you, they will want you to be a C corporation and not an S corporation or an LLC. I saw a question over there.
When you say that as long as there is a corporation, there is no personal liability, but to that—
In general, in general, there are exceptions, but—
To what extent is there no personal liability? Like, can I poison someone?
Can I—
I say as a company, if I make it as $100, I mean—
Yeah, that's—
It just doesn't make it— The United States is a safe place to live.
Yeah, so that's a great question. If I'm, I don't know, let's say I'm Jeff Bezos and I'm running Amazon, and in my capacity as the person running Amazon, I go down to the truck warehouse and you know what I do? I cut the brake cables of all the trucks and I allow them to run willy-nilly in the streets crushing pedestrians and crashing into rivers and that kind of thing. I'm gonna be personally liable as Jeff Bezos for sure.
Right.
That is an independent act of malice, and so forth. If, on the other hand, I'm Jeff Bezos, and I set a really tight delivery schedule, and it's so tight that the people driving the trucks are getting into accidents and kill exactly the same number of people, more than likely, I'm not at all liable. Right? I simply was trying to execute my business judgment. Now, could those people who lost their husbands and wives and children in these accidents, then come and try to sue Amazon? Of course they could. But then— but not Jeff, even though Jeff made the decision. Precisely right. They can sue the corporate entity, but can they sue Jeff? No. Monsanto—
And they can only tap into the corporate resources.
You're reading my mind. Exactly right. So Jeff may have $1 billion. Amazon may have no profits at that time, have no ability to pay. Well, that's fine for Jeff.
Right.
You can only sue the company up to the limit of what the company has in it. And so therefore, one of the requirements of incorporating is you must fund the company. To what level? Well, if you're starting a gym, you know, maybe a few hundred dollars, thousands of dollars. If you're starting a business that hauls away nuclear waste, more money. But there's a certain amount of flexibility and judgment. And again, if that nuclear waste spills on someone, you are not personally liable unless you did something like cut the brake cables of the truck. Only the business is liable, and then only to the amount invested in it. Now, you may think this is good, you may think this is horrifying, but the reason that countries set up this kind of a regime is so that more people will invest in businesses and so that more people will try to start businesses. After all, let's take the flip. If you thought, gee, I could be sued by a lot of people personally, and they would take away my money and they would put me into bankruptcy court, you might think twice about starting a business. The government says, forget that, we won't let them sue you, we will block them, we will put every obstacle in their way. All you have to do is file some paperwork with us, pay a very small fee, and you're good to go. It's really the best deal going. So incorporating or setting up a company, setting up an LLC, limiting your liability is an incredible deal. And the only reason that the government extends this possibility to you is because they want more people to start businesses and they don't want them to say, gee, if I do this, I could get sued personally, therefore I won't do it. In the interest of time, I'm going to move on quickly, but let's come back to you at the end because I know we're doing a Q&A.
