Choosing the Right Legal Structure and Governance for Your Company
Well managed and governed companies raise capital more effectively, have happier, more engaged employees, and tend to produce clear paths to liquidity for their investors. So establishing the right legal governance structure early is a key to business success.
As a company founder, you get to decide how to set up the business. It falls to you to define the core elements and then tie them together in a manner that increases your chances for success.
What you need to know:
- What’s your purpose?
- What corporate form and structure are most appropriate for the company based on that purpose?
- What type of corporate governance?
- What are the corporate roles, responsibilities, reporting, and accountabilities?
What’s Your Purpose?
At Rev1, our purpose is to help entrepreneurs build great companies; we focus on those entrepreneurs building high growth companies. These businesses are solving big problems for huge markets.
They disrupt industries by changing the way that companies fuel their fleets. They improve the lives of patients and families by creating gene therapies to demonstrate functional improvement in muscular dystrophy. They help Fortune 1000 companies retain and grow talent through software-driven, groundbreaking mentoring initiatives.
These are companies with big ideas and big plans—companies that typically require external capital to achieve their goals. The kinds of companies that attract investment from strategic partners, angel investors, venture capitalist, and others.
And that expected need for future capital and how the companies will use it prescribes the corporate structure that is most appropriate.
There are broadly six types of corporate structures. Each structure has advantages and disadvantages. Considerations include management and operational control, ownership, paperwork and filings, taxes, liability, long-term objectives, and ability to raise capital.
- Sole proprietorships, S corporations, and partnerships can accept investment only from their owners, and therefore are not a fit for a high growth entrepreneur who anticipates eventually raising investment capital.
- Benefit Corporations are a specific type of for-profit corporate entity authorized in some states that can accept institutional investment, but are different in purpose from a traditional C corporations and therefore, not generally a fit for most high growth startups.
- Limited liability companies (LLCs) and C corporations are appropriate for high growth businesses that plan to raise external capital in one form or another, including certain types of federal grants and contracts. Angels, venture capitalists, and institutional investors invest in limited liability companies (LLCs) and C corporations.
The LLC and C corporation structures give entrepreneurs the most flexibility and clarity in terms of attracting other money, in setting up stock incentives for employees, and in making it structurally straightforward for another corporate entity to acquire your business, for you to acquire other corporate entities, or for the company to IPO.
An important consideration between LLC and C corporation are the tax rules for recognizing loses. Generally speaking, an LLC can take loses in the year that they occur to offset other income. A C corporation’s loses may be taken against revenue from the corporation, with some carry forward provisions. For these and all tax matters, consult your attorney and qualified tax advisors.
If you know you will want to raise money eventually, figure out where you expect that money to come from. Can you be certain at this point that investment will always and forever be from individuals and never from venture capitalists or institutions? If so, then the LLC structure may suffice.
If your plan is to make your business a family or employee-owned company, you might organize as an LLC and leave it that way forever. But if your plan is to make the business attractive to the full range of investors, including angels, venture capitalists, strategic partners, or institutions, making it as easy as possible for your targeted investors to invest may lead you to structure the business as a C corporation.
Seek Legal Expertise
Getting excellent legal advice is summed up by an old TV commercial for oil filters: “You can pay me now or pay me later.” The point being a little money now for the right product or service will save you many thousands if not hundreds of thousands later. Trying to save money on incorporating and structuring your business can actually result in lawsuits, and investors refusing to invest until the old structure is changed and any trailing liabilities eliminated.
Setting up company structure is in reality a straightforward process and in the hands of competent advisors, should not be complicated: Do not try to go it alone. Do some research and hire an attorney who has structured high growth businesses before, someone who specializes in working with startups and entrepreneurs. Budget for a few hours of that expert’s time. It may cost a couple of thousand dollars now, but can you’re your company tens of thousands in the long run.
The attorney/founder relationship is one of the most important—and hopefully enduring—relationships in the life of a company. We’ve seen many of these key partnerships begin with structuring the startup, mature, and continue for many years.
Corporate governance is the systems, rules, practices, and processes by which a company is directed and controlled. It involves balancing and aligning stakeholder interests, including shareholders, management, employees, customers, suppliers, financiers, and the community.
If that sounds potentially complex and overwhelming, it can be. But that doesn’t mean you should ignore it or leave it to someone else to figure out.
Like many startup entrepreneurs, you may not have much, if any, experience in working with a board of directors, let along understanding a startup board’s role or legal obligations. You also may believe that you can delay thinking about corporate governance until you have outside investors, that it’s too much work initially—and that’s a mistake.
Here are just three excellent reasons to form a board of directors before the company has investors or goes public, whether required by state law or not:
- Most entrepreneurs don’t have experience working with a board. Better to learn how these relationships work before you have investors than after.
- Company founders should seek alignment with their future boards. If an entrepreneur wants to significantly influence who sits on their board, they can affect that by building a strong board before they raise money. Develop future board candidates and relationships by seeking out individuals who have knowledge and experience that is relevant to your business and asking them to serve on your startup’s advisory board. (Learn more about the benefits of advisory boards.)
- If, as a seed stage company, you show up to investors with a stellar a board of advisors, especially if those advisors are recognized in the industry or seen as leading technologists, the opportunity for the company getting funding increases dramatically. Why? Because investors see that the startup has oversight and supervision and that the entrepreneur has willingly added advisors to help keep the company on track.
Invest time and thoughtful preparation in determining the best possible structure and operational systems for your company. Retain exceptional legal and accounting counsel. Build the best board that you can to help set strategy and then evaluate the company’s tactics, performance and provide the necessary checks and balances for management.
Rev1 is not qualified to offer legal or tax advice. It is not the purpose or intent of this article to do so. Consult an attorney and qualified tax professional.