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Episode Date: November 19, 2020
https://youtu.be/HZ5bzb8A25s?t=5
Top Insights
It was scary for me to engage with big (law) firms when I was in my younger years. I didn't have a lot of money in my bank account. What you find is that truly great firms want to grow with you and want to get in early. Don't be intimidated. - Jason
- VCs prefer C-corps because LLCs have pass-through taxation.
- Everybody's happy until they're not. IP assignment agreements are critical.
- Cleaning up legal issues will cost a lot more money and time to fix later on. Set everything up properly from the beginning.
Startup founders often think certain things are simple and they'll just use a form off the internet, and without fail, they mess something up. It will cost 3,4, or 5 times the amount to actually fix it. - Becki DeGraw
- LLC (limited liability company): They have limited liability. Members are not liable for the debts of the entity vs in a partnership they are personally liable. It has a pass-through tax treatment, which means the entity itself is not taxed, and instead the income or losses are distributed down to the individual members, who then report that income or loss on their personal tax return and pay taxes that way. That's why VCs don't favor LLCs. They don't like pass-through tax treatment. It would be too hard to manage pass-through taxation for each portfolio company. Here's a simple explanation of why:
- A fund can have hundreds of LPs and the LPs invest different amounts into the fund. If that fund has 75 portfolio companies and 200 LPs, and 25 of the portfolio companies have to distribute money, you're talking about 5000 legal and accounting documents that have to be distributed. That's why VCs don't entertain LLCs.
- C-Corporation: When a corporation has income or loss, they report that income or loss on their entity tax return and pay taxes. Then when the corporation pays dividends to shareholders, those dividends incur income-tax liabilities for those shareholders, even though the earnings that provided the cash were already taxed at the corporate level. This is called double taxation.
- If you're not sure that you're going to raise VC funding and you expect to have some revenue, then starting as an LLC is the right approach, as long as you keep it small and simple.
- Before you take any money you should convert to a C-corp. It's an easy process to convert an LLC to a C-corp if you haven't taken any investor money. Don't wait until you've got a lot of employees and the business has grown large. Complexities will add cost to the conversion process.
- Jason recommends having a very brief email discussion that breaks down how much each co-founder gets and what happens if one of them decides not to move forward at a later date. This way you have an understanding between the two of you — of what your goals are.
- Something in writing is better than nothing.