How does one self fund a start up properly?

https://news.ycombinator.com/item?id=218624

by coglethorpe • 18 years ago

32 47 18 years ago

news.ycombinator.com

I have a startup (I plan to set up as an S-Corp) and I'll want to add some of my personal funds to it as I earn side money, but I want to know the right way to go about it. If I pay myself with equity can I create additional shares, or do I have to transfer shares? If I consider it a loan to the corporation, do I need to specify terms of repayment?

I'm concerned about regulations regarding share sales as well. I'm more concerned about the company making money in the long run than getting a loan repaid, so shared might be the right way to go, but I'm not sure.

Any websites that go over this for the self-funder, or person seeking a family and friends round?

Once things get going, I think I can manage it with it's own funds, but the first steps confuse me.

PS - I did submit this over the weekend, but the timing (around midnight on Saturday) may have prohibited responses. Thanks.

iamdave• 18 years ago

"If I pay myself with equity can I create additional shares"

If you don't mind the embezzlement/laundering/fraud charges.

http://www.inc.com/resources/finance/articles/20040801/noVC....

Fantastic article for what you're wanting to do, especially when it talks about cash flow, though you'll be cutting it close there.

coglethorpe15• 18 years ago

Thanks, I'd like to avoid jail time if possible. :-)

I can still loan personal money to the corporation, right? I need an example of how to go about that. Has anyone here done that? My plan was to seed the company, then loan it some cash a few months in. I'm only talking about 10k here.

The Inc. article is good, but it's short on the details I need. Anyone have links to this sort of situation? I can imagine people with tech startups end up in this situation all the time.

qaexl3• 18 years ago

You have to document it in board meeting, and spell out the terms of the repayment. If you want to keep liability protection. From what I understand, if the opposing lawyer can successfully argue that you appear to be commingling funds and not operate as two seperate, distinct entities. How this is determined is not so much by a clear set of rules so much as a set of heuristics. They look at the formalities you've done, and other things such as how much you have loaned versus how much the corp was capitalized as (laibility-to-equity ratio) -- you'll want to ask your lawyer what is the best way to go about loaning money to your company, how often and how much you can do so.

tptacek8• 18 years ago

Embezzlement charges? Where is that coming from? If he doesn't have outside shareholders, he can change the structure of the company by fiat 10 times a day from a Rails-scaffolded web-app that generates new company documents, and it's all perfectly fine.

coglethorpe15• 18 years ago

"a Rails-scaffolded web-app that generates new company documents"

Forget the company. I think I just found my entry for the next YCombinator contest. :-)

tstegart3• 18 years ago

Why the S-Corp route? LLC's are more popular for good reason. Either way, pick up the Nolo series of books (or get them from the library). They are actually quite good. http://www.nolo.com/resource.cfm/catID/9FA25870-14F1-4657-97...

coglethorpe15• 18 years ago

I've considered LLC as well. Will that look ok for a national company? I guess I fear a stigma of being seen as small if I have "LLC" at the end of the company name. Is that silly? The S-Corp and LLC seem nearly the same for what I want to do.

Thanks for the NoLo link. I'll probably pick one of those books up.

But more importantly, once the LLC/S-Corp is formed, how can one properly feed it capital? And what about the money used to set up the corp? Can that be private money? I guess it would have to be because the corp doesn't exist yet, right?

bbrannigan• 18 years ago

A LLC should look fine for a national company. There are a number of large companies that are an LLC or have subsidiary LLCs (E-Trade for example).

I would recommend that you find a lawyer and an accountant for at least an initial conversation about this. The selction of an entity-type and how you fund it are very specific to your situation and objectives.

tonystubblebine• 18 years ago

Regarding the fear of being seen as small. This is probably a common fear and it's certainly something I felt at the beginning. Our initial documentation referred to "we" when it was really "I." However, it's good to get over this and embrace your true size. It gives people a chance to be impressed with you.

For example when we launched we were competing directly with Ning which had an ultra famous founder, 40+ million in funding and a two year head start. During an interview with TechCrunch, the reviewer said, "Oh, you're a one-man Ning."

That sounds a lot better than, "you're a third-rate Ning." We've since gone off into a vertical where we can actually be the leader but we're still upfront about size. People give a us a lot more leeway and respect for it.

Also, when will people see your incorporation status? The only time people see ours is when we bill them for services. There's no way to hide your size then. It's not like you can present a bunch of fake personas. So your size is going to come out in other ways and when it does you don't want to look like a faker.

tptacek8• 18 years ago

Nobody cares whether you're an LLC or an S-Corp. You aren't obligated to put the letters after your company name.

The major issues are:

* As soon as you have two "classes" of people (founders and employees), you need to be an S-Corp to give the employees equity.

* As soon as you want to take W2 wages instead of 1099 distributions --- that is, as soon as you want to stop paying your own taxes quarterly --- you need to be an S-Corp. S-Corp Principals take distros, not paychecks.

tstegart3• 18 years ago

AOL was an LLC for quite a while. Might still be.

qaexl3• 18 years ago

If you look around, you'll see some interesting things.

When I go to Arby's, I sometimes read who actually owns their registered trademarks. It reads something like "Arby's Intellectual Properties, LLC" (don't quote me on that, but it is an LLC).

My apartment complex is fairly sizeable. Before it was sold off to the current owners, the property itself was owned by an LLP and the property management arm is an Delware LLC. This is a national property management firm.

The last time I was out on the road and stopped at a truck stop -- Pilot -- I noticed that Pilot was owned and operated as an LLC.

In Columbus, OH, there was a stadium built maybe eight years ago, called the Nationwide Arena. Nationwide Insurance may have sponsored it, but the stadium itself is held in an LLC.

My point in this is that there isn't really a stigma attached to an LLC. And looking at it in a different way, an S-Corp and an LLC are two different investment vehicles for any future investors you might be looking for. From those above examples, you might see that LLCs are often used when it comes to holding assets. And as for an S-corp, you can always convert it to a C-corp later on; and depending on the size and how much isolation you want to protect the business assets, you'll end up with multiple entities anyways.

Money used to setup the corp can be reimbursed by a board meeting to the incorporator (either with the LLC or the S-Corp) and declared as "capital expenses". It has to be documented; in the case of the S-corp, it should be documented in the initial board meeting and recorded in the minutes. The money you reimburse to the incorporator is paid back in a lump sum, but the capital expense itself is amortized and carried on the books for X number of months (for which, I don't remember value X off the top of my head).

But yeah, it would be private money. So you'll want to figure that into your calculation when you setup how much you're going to capitalize the company at.

With a Corp, you take additional capital by selling more shares. If you don't have any more shares to sell, you will have to amend the articles of incorporation to authorize more shares, and you generally have to file the amendment with the state government. If you have some shares left, the company can sell them to the investor. Often, there are buy-sell agreements in place, to protect the current shareholders from suddenly getting a shareholder they don't want (massively scaled up, it is like the hostile takeover attempted by EA with TTWO, or with the whole Ichan/Yahoo/Microsoft).

LLCs sell additional membership interests, and how you account for that depends on how the operating agreement (read: software configuration) is setup. Some LLCs express ownership in terms of percentages; some express ownership in terms of numbered shares (just like a Corp). How you determine how it is expressed is explicitly spelled out in the operating agreement. The buy-sell agreement you find in a corp is often folded into the operating agreement (example: member may not sell their shares without the unanimous approval of all the current members of the LLC).

There are tons more stuff. Definitely look into the Nolo books. The publisher was started by a lawyer, the books are generally comprehensible. They lay out for you a number of different options you might have so that when you walk into a lawyer's office, you can make informed choices. And just like configuring software, it isn't necessary to enable all the options -- some might even be security risks -- it depends on what you are trying to achieve.

coglethorpe15• 18 years ago

You may have helped me find some forms that do just what I need. Thanks!

http://www.nolo.com/resource.cfm/catID/401F3CD9-B02C-4FD9-BC...

iamelgringo• 18 years ago

If I'm not mistaken, I really don't think that you want an S-corp for a technology business. From my understanding, with an S-corp, all shareholders must be US citizens: http://www.allbusiness.com/business-planning/business-struct...

So, if you want to take VC funds, you're going to have to change to a C-corp. There's also a lot of maintenance that has to be done as an S-corp or a C-corp, that you wouldn't have to do if you incorporated an LLC or as a sole proprietorship. If you're just starting off, this might be a little tough to keep up with.

If it's just you, have you thought about setting up a sole proprietorship? You pretty much get your "doing business as" paperwork filed with the county, pay the business license fee and you're in business. After you do that, you can set up a separate bank account with your businesses name, and run the business off that bank account. Business taxes are handled on your own income tax. If the business needs money, put it in the account, if your business makes money, take it out. And, keep a decent set of books that separates your personal finances from the businesses.

As for an LLC, the primary advantage that will give you over a sole proprietorship is protection from getting sued. That is, if your company gets sued, they can't go after your house and bank account. And, it's possible to have multiple people as members of an LLC.

I've been mulling these same questions over, and my decision has been to work as a sole proprietorship until I have to incorporate. And, as far as I'm concerned, I'm not going to have to incorporate until I need to offer shares to employees or take outside investment.

coglethorpe15• 18 years ago

All shareholders would be US citizens and I don't think this will be (or need) VC funding.

This isn't a "tech" startup in the YCombinator sense, but there would be multiple people involved and I want to make sure it gets done right. A corporation is partly there to protect our assets and to declare ownership.

tptacek8• 18 years ago

What everyone always tells me is, "forget about getting company structure right before you take an A-round, because the VC's lawyers are going to re-do everything anyways".

I'm not sure why, in what's effectively a sole proprietorship, you'd do anything other than an LLC.

iamyoohoo• 18 years ago

All shareholders must be US citizens "or residents".

michaelbuckbee• 18 years ago

Amazon Web Services group is actually an LLC, and I'd like to think they know what they are doing, though of course your situation may vary

http://aws-portal.amazon.com/gp/aws/developer/terms-and-cond...

coglethorpe15• 18 years ago

I assume that's an LLC held by Amazon, Inc, which I assume is a C-Corp as it is publicly held. They might have it set up as a smaller corporation to protect the bigger corporation from liability.

shimonrura• 18 years ago

Are you the only person involved in the company? If so, what's the reason you want to incorporate? If not, or not for long, what are the current/expected roles of your partners/investors/creditors/etc.?

I ask because I think it's common for hackers to get distracted by the myriad of different options (it's a kind of engaging puzzle) and overbuild the business side before there is a legitimate need.

coglethorpe15• 18 years ago

There will be four of us as shareholders, and possibly an outside investor.

tom• 18 years ago

As much as I respect the opinions and knowledge of much of the HN community, this is really one of those instances where you need professional help. Don't try to "do it yourself" this, it's too important and will have lasting effects on the company, you, and your investors. Seriously, get a CPA or new biz lawyer (local to your state - or where the biz will be legally located) and talk to them. Get some help with the paperwork. Go to someone who can really explain it all to you, as there is a lot and you might find your eyes glassing over (I know mine did). I realize that you're cash poor, and don't want to waste capital, but sometimes you gotta pay to play. A little cash outlay now can save you a lot of heartache later.

Good luck!

EDIT: this is a great resource to go into any meetings with the folks mentioned above knowing what you're talking about though. Knowledge is power! :)

coglethorpe15• 18 years ago

Thanks for the advice. I do plan on speaking with some professionals (lawyer, accountant, maybe therapist:-) ) about this as well. But HN is a great starting point. I really do appreciate the help I'm getting here.

Allocator2008• 18 years ago

Check out www.delawareinc.com for info on how to incorporate as a delware company to get a low tax bracket.

the way I read it, you can incorporate with 1500 shares at only a $60 a year min. tax rate. This way you can keep your costs low, and not have the limitations of an LLC.

tptacek8• 18 years ago

Delaware offers more protection if you get sued, but is not particularly tax-advantaged, nor is it the easiest place to incorporate. There are favorable tax implications to Nevada. Otherwise, as far as I can tell, picking a venue to incorporate in is a lot like picking a domain registrar: go with what's cheapest. Don't do NY --- you have to run an ad in the paper!

jeremyw• 18 years ago

Looks like that's out of date. Now 3,000 shares @ $60.

http://www.corp.delaware.gov/frtaxcalc.shtml

epi0Bauqu• 18 years ago

Why would you use equity? If you already own 100%, it won't change the equity %s, so what's the point? And it will create headaches in accounting like increasing the fair market value of your shares.

Just loan the corporation money on an ongoing basis as a loan, and then pay it back to yourself over time. The only thing you have to worry about here is that you need to pay yourself market rate interest or the IRS won't like it if you get audited. But you don't need to make it complicated by paying interest over time. Just add it up all at the end and pay yourself back in a lump sum.

tptacek8• 18 years ago

I strongly disagree with the first part of your argument and strongly agree with the second part, for a totally different reason.

First: your shares having a fair market value is a "win" condition. Before steady cash flow, even after the (unlikely) VC A-round, they don't really, no matter what you say. I wouldn't make practical decisions based on the eventual number attached to shares.

Second: do the loan, don't buy more equity. What can happen is, a year from now, that loan gave you more equity than your partners. The money seemed like a big deal when you gave it it, but now that you're making $300,000 a month, nobody cares. Now there's friction over the fairness of the equity purchase you made. Not worth it.

icey• 18 years ago

Honestly, you should set aside $1500 or so, and go talk with a lawyer that specializes in this sort of thing. It's risky to take advice from the internet when we could not possibly know all of the intimate details of your situation. A lawyer knows what questions to ask to help protect you and your money.

coglethorpe15• 18 years ago

I plan on talking with a lawyer and maybe an accountant about this as well.

tptacek8• 18 years ago

Don't get rolled. You can spend a lot more here than you want to at this stage of your company.

[Edit] You have an outside shareholder and non-founding fulltime employees. I retract my previous statement.

bookhuddle• 18 years ago

Hi.

I recommend you meet with a lawyer familiar with this type of stuff. If you don't already know or have recommendations for a good lawyer, you can start by visiting your local Small Business Administration or SCORE branch to speak with people there for free. They can also give you some references.

tstegart3• 18 years ago

I second SCORE, I've heard nothing but good things.

timae• 18 years ago

To answer your primary question, it doesn't matter that you "set aside" funds to use for the business. As long as you can keep accurate records of what you spend on your business, you'll be fine from an accounting/legal perspective. As far as the legal structure of your company, you will probably want to choose from either an S-Corp or an LLC because both allow you to avoid being taxed twice. You mentioned you weren't seeking VC money, but even if you were, that shouldn't influence your legal structure choice too much. Here are the key differences:

1. Self-employment taxes: A primary advantage of an S-Corp is that you can avoid having to pay a portion of your self-employment taxes, if you plan on taking more than "a normal salary" for yourself from the business. (I can elaborate on this if you want.)

2. Acquired/Investors: S-Corp's sometimes make it easier to be acquired or to be invested in.

3. Ease of operation: LLC is very easy to setup and maintain from an administrative perspective. (I've always heard this, but admit I don't know exactly how "hard" an S-Corp is, paperwork wise, or how "easy" an LLC is)

4. Shareholder limit: S-Corp can only have 100 shareholders, LLC doesn't have this limit.

5. Profit distribution. S-Corp you must distribute profits in proportion to equity ownership. LLC can distribute however it wants. (This one seems odd, and although I know it to be a rule, I don't know the details of how its carried out or enforced)

qaexl3• 18 years ago

Disclaimer: I'm not a lawyer, this is not legal advice. Most of this stuff I've read through Nolo publications and other books and the rest I heard while talking to people, so check with your own lawyer.

(3) S-Corp like a C-Corp requires you to act in ways demonstrating that the corporation is a separate business entity, with its own agenda. If it can be demonstrated in court that you are mixing your personal assets in with your corp, then the court can decide that you no longer receive the liability protection of the corporation. This means doing things such as having formal meetings of the board of directors, keeping minutes, having resolutions for the major business decisions (even if it is affirming the "actions of an employee").

LLCs, on the other hand, from the last I've read of them, do not have the case history saying how much formality is required. According to Nolo's book, you're better off running it in the same kind of formality as a corporation, just in case.

One thing LLCs can do well, is that they are meant to offer the same kinds of liability protection as LLPs (limited liability partnerships), which can be often stronger than a corporation. But it depends on how you set up the LLC's operating agreement.

(4) There are more limits to shareholders than just 100 shareholders for an S-Corp. The shareholders must be US Citizens, and a natural person. In other words, if you have a VC fund or an Angel investing money in from their business entity, you will have to convert the S-Corp to a C-Corp.

LLCs may not have the shareholder limits, but selling membership interests over a certain number will trigger SEC regulations -- the same as shopping for angel investors for a corp.

(5) Caveat: distributing profits from the LLC however way you want requires some extra bookkeeping. You will have to track the tax basis of every single LLC member, and track how it changes depending on money disbursed or put back into the LLC. There should also be clauses documenting how this works in the operating agreement. It is something you'll definitely want to ask your tax lawyer or accountant about.

As far as I know, this feature was inherited from the LLP. It lets you defend the assets held by the entity by starving out creditors -- you have to pay taxes (assuming the LLC elected pass-through taxing instead of corp taxing) on the profits regardless of how much is actually disbursed.

But to reiterate: I'm not a lawyer, this is not legal advice. Most of this stuff I've read through Nolo publications and other books, so check with your own lawyer.

dawie• 18 years ago

http://gigaom.com/2008/06/15/venture-capital-angels-or-boots...

http://glinden.blogspot.com/2008/05/starting-findory-funding...

augustus• 18 years ago

I have an S-Corp for my technology startup and it works great.

The main thing regarding accounting is to create separate accounts for your business.

Its best to have a business checking account and credit card account exclusively for business.

If you pay for something from your personal account like your personal credit card simply show it as a loan from your business to yourself.

You can keep records in this manner until you reach tax filing season (mar 15 deadline). At that time you can use a CPA accountant to file your taxes and he should be able to assist you with your other questions.

Focus on keeping very accurate records and ethical in what is being used for business and you should have no problems during tax time.

If you are taking on a loan in exchange for shares, I would definitely advice you to get a lawyer to write out the terms and hopefully you can afford it then.

coglethorpe15• 18 years ago

Wow. What a day. I have to thank all of you for sending this question to the top! It overtook a Flash game and even battled off an iPhone reference for a while.

I certainly ended the day smarter than I started it. I found the Atlanta SCORE branch and scheduled an appointment with a counselor to start with. I'll get an attorney involved if need be.

Of all my business ventures/attempts, I feel the best about this one. I'll keep people posted... Thanks again and feel free to keep the comments and karma coming. :-)

RobertL• 18 years ago

You are worrying about the wrong things cog....

What you need to be worrying about is whether or not your product will attract any customers.

Once you focus on that you should be able to relate to what Spartacus did and said before he marched off into his last battle. After killing his horse in front of a group of his soldiers he declared that if the battle is lost the horse will not be needed anymore. If the battle is won than there will be a bounty of Roman horses to choose from.

It's kind of the same way with startups. If your product attracts customers and the money is flowing in just go to an accountant and have him work it all out. If the product flops then it doesn't matter what the heck the rules are. You don't get the play the game anyways.

coglethorpe15• 18 years ago

I am Spartacus. :-)

The product already attracts customers, but a team is needed to grow our ability to make and sell the product. There is an actual physical product here, but we need a better way to make and sell it.

How does one self fund a start up properly?

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