Why and how we registered our start-up as a C-Corporation?

One of the early tasks that we took care of it, during the first couple of weeks we started, was the registration of our company as a C-Corporation. To my surprise I ended up putting a lot of hours into research and making the choices that comes with the legal process of registering a company. At first glance, it seemed to be an extremely simple task but then as we went through it there were number of questions that we needed to answer and it took much longer than what I expected to come to a conclusion that made sense. In this post I will summarize what we learned, decisions we made and our logic to make those decisions. I summarized them in the form of Question and Answer so that it is easier to glance through and find the specific questions you are interested in. ​Intuitively you would think registering a business is all about choosing the name. It is of course required and is a hugely sentimental step. However there are three other more serious questions that you need to answer when you are registering your business legally. Here they are in the order we did research and answered:

1. Do we need to register our start-up legally?

When it comes to registering the company, the first question that we needed to answer was whether we actually need to register it as a legal entity. Many start-ups go through the product development phase without any legal status. As a matter of fact, many early/idea stage investors, VCs, and incubators prefer the start-ups not to be registered. Mostly because when it comes to bringing on an early investor they would rather to have control over the type of shares being issued and so on.  In their application Q&A section they ask the applicants not to register the company prior to applying for their program. You can read about their reasoning on the Q&A section of their website under the "sustainability" section. Despite the investor community and incubators' reasoning there are benefits to thinking about this question. Fore one, it forces you and your co-founders to discuss roles and responsibilities. Also, as you will see later in this post, to register your business you need to identify number of shares to authorize and issue and to whom they are assigned and that is a great conversation to have with your co-founders. 

What we did: After reading the descriptions of the options available and comparing them based on the business structure comparison table provided by San Francisco Business Portal we disregard Single Proprietorship, General Partnership, Limited Partnership, and Limited Liability Partnership (LLC). Then we had to choose between S-Corporation and C-Corporation and we  chose to register the company as a C-Corporation for the following reasons: 

• Initially our preferred choice was S-Corporation due to tax pass-through benefits. In a C-Corp strcutured you are double-taxed; once on your comaony's income and then on your perosnal income (we knew we will be home-based for at least the first year of our business and wanted to take advantage of tax benefits that will come with that)
• But S-Corporation is limited to one class of share. If we ever raise capital then we cannot use one class only. Investors and founders will ask for a preferred class
• Changing from S-Corporation to C-Corporation will cost couple of hundreds and has administration issues that we preferred to avoid
• We didn't really expect to raise capital at least in the first year, but we knew we will soon need a technical developer who would most probably ask for shares
• Also, double taxation only happens if we decided to distribute income to the shareholders in the form of dividends - which is not expected for a long time, even if we were to be profitable from day one. We decided that when we make money we will use it for building the business not paying dividends
• ​Ultimately, we decided to take the business serious and act as if it was the one and only thing that matter. If we were not in the product development stage, we never would have even thought about S-Corp. 

2. Do we register the company on our own or use an expert help and/or advice?

You can certainly register your business yourself. You need to choose a name, check whether it is available, fill the forms required, get the permits you need (depending on your industry, city, country, ...), and file all the required documents. You can also hire a lawyer to take care of  the process for you. Third alternative is to use companies like https://www.legalzoom.com or https://www.priorilegal.com. These are legal services on-demand platforms supported by lawyers and accountants if needed. 

What we did: We chose to use Legal Zoom for two reasons:

• Needed peace of mind that everything is being registered properly and we are compliant with legal requirements as we preferred to spend our time on product development
• Later on we will need someone's help to develop our terms and conditions and we wanted to combine all required legal processes in one place

3. How many shares, at what value and which class of shares to authorize and issue?

In my point of view, this is the best and most valuable section of this post if you are about to go through the registration process of your company (yeah, your welcome!). As you go through the Legal Zoom process (I'd expect it is the same if you choose to go through the process in any other ways), you ,must answer four questions:

1. How many  stocks  to authorize and issue?
2. What is the value per stock?
3. How many classes of stock to authrize (preffered v.s. common)?
4. What is the date for the start of the fiscal year?

I was actually not ready to answer these questions. I got caught off guard and had to stop the process, call my co-founder, do tons of research and go back to finish it one week later. The most informative blog that helped us answer those questions was a blog called StartUpLawyer. 

What we did:

1. 10,000,000 stocks authorized . We didn't want to run out of number of shares to grant to people if and when we start having "advisers", "consultants", "employees", "investors", and so on.
2. $0.00001 per stock. This hurt my feelings a bit because I had to admit the company is not worth much at this stage. Although I already knew it but it was hard to swallow. At the end, logic prevailed as it should have. We didn't want to make it expensive to buy the initial stocks ourselves. Assuming that we were giving 80% of the stocks to the the original 2 founders (we made that decision) then we needed to make sure we pay less than $100 at the beginning). Also we decided to keep 20% of the stocks unassigned to anyone. We kept it for potential investors or early employers that we might bring on later. 
3. Yes to "dual" classes of shares authorization: I read about many start-ups that set the structure at the get go with a preferred class of shares to make sure they will have enough control over the the company once they bring in investors. At first, we decided not to do that and just keep common stocks. First of all, we didn't believe control needs to be legally enforced (assuming that if we hire the right employees and get the right advisers and investors).  We thought the right investor for us is the one that is willing to keep control in the hands of the original founders due to their ability to run the business and make the right decisions. Legal enforcement at this stage is too early and signals lack of ability to put together a good team. However we ended up with 10% preferred shares authorized and 80% issued split between the two founders equally. So basically we kept 20% of the stocks un-issued, - 50% common and 50% preferred because we decided to maintain the right to issue preferred shared if required and we didn't want to limit our options.
4. 31st of December as the end of the fiscal year: Basically it is not a big deal but I was tempted to put my birthday as the date (sentimental value). Also thinking that for paying taxes let's just gather the documents one time and submit both corp and income taxes at the same time. So the timing is aligned with individual income tax time. But I read that depending on the capabilities of your accountant or finance department, you probably don't want to get too cute with this decision. Keeping things on a regular quarter (end of March, June, or September) will make reconciliation with other accounts, like payroll, much easier.  Also there will be complications due to profit provisioning and accounting stuff that I didn't understand much and I decided to take Quora contributors' suggestion and choose 31st of March (not too far my birthday either :)).

Before I wrap-up, I have to say that registering your legal structure will cost you. We paid around ~$350 to Legal Zoom for the initial services (including checking the availability of our name, filing with state and federal governments, obtaining our EIN number that is needed for hiring employees). We also paid an additional ~$150 for an add-on service to make Legal Zoom our authorized agent. This means they give us a calendar and an alert system to remind us of the frequent actions we need to take to stay compliant with the legal requirements of being a Corporation (e.g., annual reports, taxes, etc.). One last expense we incurred was an additional ~$350 for Legal Zoom partners to file our company's annual taxes. You can choose not to do the last two options and either work with another company or take care of it on your own. We chose to pay for it to make sure we do not need to worry about any legal and compliance issues and focus on what matters the most which is developing our product. Also be aware that you will receive bunch of letters form the government and some commercial calls form accounting firms and Dun and Bradstreet to sell you more stuff. We chose to rejects them all and stay focused on our product development priority and minimize noise.

Hope this post saves you some time as you go through the registration process of your start-up. If you are at that stage, let me just congratulate you. When the registration was done and we received our official documents in a nice package from Legal Zoom, it actually made us really happy and felt great. We knew that we are serious now and to me that was the most important reason we registered our company.