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Ask the Experts – Part 1: Getting Started

We’ve dealt with hundreds of early stage companies over the years and there are definitely some questions that seem universal for entrepreneurs. In Part 1 of Ask the Experts, we’ll address choice of business entity, when to talk to VC’s, and whether to pay yourself. 

Everyone tells me I need to be a C corporation.  Why a C Corp instead of an S Corp or LLC?

First we have to make an important distinction – both S corps and LLC are what’s known as “flow through entities” where the tax impacts of those businesses flow through to the shareholders. A C corp is not a flow through entity and while all three business structures come with their advantages, investors are most likely to fund C corps. The reasons are complex but most investors don’t want the tax impacts of their investments to flow through to them personally. With a C Corp, depending on how the acquisition is structured, the corporation must pay tax on the gain and then the shareholders pay tax on the amounts distributed from the corp, otherwise known as “double taxation.”  Still, S corps and LLC can have some advantages including the founders being able to personally utilize the losses generated by the company and if you’re lucky enough to stay as an S corp or LLC through an exit event you will avoid double taxation.  If you’re not seeking funding, it could be beneficial to remain an LLC and reap these potential tax benefits. But before you begin meeting with VC’s, be prepared to make the switch to a C corp structure to improve your chances of receiving outside funding. 

When should I be talking to VC’s?

The quick answer is all the time, but make sure it’s not just when you need money. We go into greater detail in Positioning Your Business for VC Investment so make sure to check that out if you haven’t already, but the biggest mistake that many entrepreneurs make is talking to VC’s only when they are pitching. VC’s are in the business of getting to know interesting companies and entrepreneurs so make sure you place yourself where they are and ask for their perspectives. Establish a relationship with as many VC’s as you can, keeping them informed about what you’re doing with your business and how it’s progressing.  At a minimum, you should be able to glean some perspective from them on your sector and how a VC views your business.  This sort of VC relationship will help pave the way when it comes time to actually starting pitching for funding. 

Should I pay myself?

As the Founder, CEO, Chief Strategist, and Visionary of your company, it may be tempting to pay yourself for all those job descriptions. Don’t. Before receiving enough funding to actually pay themselves, some founders are tempted to accrue what they believe is a reasonable salary with the hopes that the accrual will be paid out to them when they receive funding.  Remember that what you’re building isn’t a well-paying job but a valuable business and the business is what your future investors will be interested in financing.  They won’t be interested in seeing a portion of their new investment into your business being paid out to you for past work. That’s called sweat equity!  Most entrepreneurs we work with don’t take a paycheck in the beginning, in fact, they often have another day job or savings that pays the bills. Investors understand that you need to live and should pay yourself a reasonable salary, but they also want to make sure you keep your eye on the prize – building an incredibly valuable business. 

If you like the information you've received here, head over to Ask the Experts - Part 2 where we talk about share based compensation, valuation, employee vs contractor and other intricacies of being a start-up.