Startup Basic #1: Choice of Entities

CHOICE OF ENTITIES
Startup@BerkeleyLaw 
Olivia Chu (BerkeleyLaw LL.M. 2017) 
Supervised Attorney: Kevin Xu

KEVIN XU/ OLIVIA CHUSTARTUP@BERKELEYLAW
STARTYOUR BUSINESS RIGHT
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CONTEXT
Entities Analysis Forming an Entity in
Delaware

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Corporation
C-Corp/ S-Corp/ B-Corp
Limited Liability Company (LLC)
Partnership
Sole Proprietorship
4 Main Business Entity Choices

Sole Proprietorship
An unincorporated business owned and run by one individual with no
distinction between the business and the owner
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• A one-person business that is not registered with the state as a corporation
or a limited liability company (LLC)
• The simplest and most common structure chosen to start a business
• A Default Status: If you are the only owner
• No formal action is required to form a sole proprietorship.
• Taxation
• The business itself is not taxed separately: you and your business are one
and the same; the sole proprietorship income is your income

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Heavy burden
Hard to raise money
Easy and inexpensive to form
Unlimited personal liability
Complete control
Sole Proprietorship: Pros & Cons
Simplified Taxation
PROS 
CONS

Partnership
A partnership arises whenever two or more people co-own a business and
share in the profits and losses of the business.
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• Joint ownership with shared management
• A Default Status: If you co-engage in a business or received non-payment profits
(UPA 1997 §§ 202 (a),202 (c) (3))
• In the partnership setting, the traditional judicial response is to demand that
partners deal with one another as fiduciaries in all matters affecting the
partnership. (UPA 1997 § §103, 403, 404)
• Duty of Loyalty (UPA §404(b))
• A partner’s duty of loyalty to the partnership and the other partners is limited
to the following: 1) accounts related to the partnership; 2) deals related to or
adverse the interest of the partnership; 3) competitions against the partnership

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General Partnership
A general partnership is an
arrangement by which partners
conducting a business jointly have
unlimited liability. Every partner to a
general partnership can actively
participate in management and may
be as responsible as other general
partners for loss from lack of care.
Limited Partnerships
Similar to general partnership, but
limited partnerships must have at
least one general partner and at
least one limited partner. Limited
partners do not receive dividends,
but enjoy direct access to the flow of
income and expenses.
Limited Liability Partnerships
A partnership in which some or all
partners have limited liability. One
partner is not responsible or liable
for another partner's misconduct.
Most LLPs are created and managed
by a group of professionals. LLPs
tend to rely heavily on reputation.
3 Types of Partnership

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Shared Profits
Decisions are shared
Easy and Inexpensive to form
Joint and Individual Liability
Partnership Incentives for Employees
Partnership: Pros & Cons
Shared risk and expense
＊A friendship may not survive a partnership.
PROS 
CONS

Limited Liability Companies (LLC)
A limited liability company (LLC) is a mix of partnerships and corporation. An
LLC is an unincorporated association that protects the liability of a company.
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• Flexible management structure: More like a contract
• No ownership restrictions and members of an LLC may be non-US citizens
• Easy and less-costly to form
• Taxation: Flow-Through Taxation

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Difficult to raise capital
Self-Employment Taxes
Members are protected from
personal liability for business
Joint and Individual Liability
Less registration paperwork, and cost less than S-Corp
LLC: Pros & Cons
Fewer restrictions on profit
＊In many states, when a member leaves an LLC,
the business is dissolved and the members must
fulfill all remaining legal and business obligations
to close the business. The remaining members can
decide if they want to start a new LLC or part ways.
However, you can include provisions in your
operating agreement to prolong the life of the
LLC if a member decides to leave the business.
PROS 
CONS

Corporation
A partnership arises whenever two or more people co-own a business and
share in the profits and losses of the business.
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• Joint ownership with shared management
• A Default Status: If you co-engage in a business or received non-payment profits
(UPA 1997 §§ 202 (a),202 (c) (3))
• In the partnership setting, the traditional judicial response is to demand that
partners deal with one another as fiduciaries in all matters affecting the
partnership. (UPA 1997 § §103, 403, 404)
• Duty of Loyalty (UPA §404(b))
• A partner’s duty of loyalty to the partnership and the other partners is limited
to the following: 1) accounts related to the partnership; 2) deals related to or
adverse the interest of the partnership; 3) competitions against the partnership

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C-Corp
The standard corporation. Multiple
classes of stock available to C-Corp..
Non-US citizens or and non-
residents are permitted to be
shareholders / founders of a C-
Corp. C-Corps are the best choice
for large companies that are or plan
to be publicly traded.
S-Corp
The main difference between a C
corporation and an S corporation is
the taxation structure. S
corporations only pay one level of
taxation: at the shareholder level.
Limited ownership to 100
shareholders. Shareholders can only
be US citizens. (No VC fund.)
B-Corp
B-Corp is a for-profit entity includes
positive impact on society, workers,
the community and the environment
in addition to profit
3 Types of Corporation

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Bad for businesses that want to hold
appreciating assets, such as real estate
Double-Tax
unlimited amount of shareholders 
Mostly costly and most difficult to form
in terms of regulations and paperwork
Easy to get funded
C-Corp: Pros & Cons
Shareholders can be non-residents
PROS 
CONS

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Limited to one class of stock only
Pass-Through Taxation
Maximum of 100 shareholders,
all of whom must be U.S.
residents or resident aliens
Straightforward transfer of ownership
S-Corp: Pros & Cons
Protect the personal assets of its shareholders.
Owner/employees holding 2% or
more of the company’s shares
cannot received tax-free benefits.
PROS 
CONS

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Ease of conversion and mergers
Transformation of the entity might be a great strategy!
Equity incentives and financings
How the company get funded? 
The right entity will even help you raise more capital
Tax
Employment Tax/ Pass Through Taxation
Governance
Who is in charge of the entity? Is the person eligible? Who will
be liable for business obligation?
4 Consideration Factors

GOVERNANCE
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Entity Structure
PARTNERS
SHAREHOLDERS
MANAGERS DIRECTORS
MANAGERS
MEMBERS
LLC Corporation
Board of Directors + Shareholders 
(State Corporation Code )
Partnerships
INDIVIDUAL
Sole Proprietorship
Single Entrepreneur
Members/Managers 
(State Limited Liability Company Act)
Several Entrepreneurs/Sharing Power 
(Uniform Partnership Act)

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Nationality Eligibility: S-Corp
Can a Foreigner, Non-citizen, Resident Alien Be an S Corp Shareholder?
• S-Corp is not eligible to “have a nonresident alien as a shareholder”  
(IRC § 1361(b)(1)(C))
• Foreigners who are “Resident Aliens”
• Green Card (Immigration Form I-551)
• Substantial Presence Test
• Physically Substantially Presence in US (> 183 Days / year)
• You have to continue to meet the test until you really acquire a green card
Yes. However, an S-Corp generally cannot be owned by a non-US Citizen.
＊This is tricky. Not highly recommended.

TAX
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Tax Structure
Sole Proprietorship, Partnerships, LLC, S-Corp
Pass-Through
The income of the entity is treated as
the income of the investors or
owners. Only taxed one time.
*Entity Income = Gross Income-Expenses
PARTNER 1
ENTITY INCOME
PARTNER 2 PARTNER 3 PARTNER 1
ENTITY INCOME
PARTNER 2 PARTNER 3
Double Taxation
Taxed twice.
= Tax
C-Corp

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C-Corp and the Double Taxation
Is C-Corp really a bad option because of the taxation?
• The C-Corp structure can possibly help you minimized the tax
• The IRS taxes different levels of profit at different rates
• Double tax issues usually only matter when the startup makes lots of money
• C-Corp can issue multiple types of stocks, which can possibly reduce tax
• Shareholders of C corps can serve as salaried employees
• The company can pay employees enough so that no taxable profits remain at
the end of the fiscal year
• The only entity form that can deduct contribution to eligible charities as a
business expense.
It depends. Generally, you might be taxed more, but not always.
* https://www.irs.gov/pub/irs-pdf/i1120.pdf

EQUITY INCENTIVES 
& FINANCINGS
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Stock Option and Fund Raising
What kind of stock can be issued?
• LLC or LLP cannot issues stock
• C-Corps and S-Corps can issues employee stock options and are eligible to issue
“incentive stock options” with special tax treatment
• C-Corps can issue “qualified small business stock.” S corporations cannot issue
qualified small business stock.
• You must be a C-Corp to get fund from Venture Capital (VC)
• C-Corps can engage in traditional VC-style preferred stock financings while an
LLC and S corporation cannot financings
• You don’t need to be a C-Corp to get fund from angel investors, but
professional investors prefer C-Corp
Stocks are used to raise funds or build the capital through the sale of shares.
*In reality, C-Corps are more easy to get funded

EASE OF  
CONVERSION & MERGERS
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Entity Converting
You probably have to convert to the entity from one to another as your business grow
• Converting an S-Corp to a C-Corp: Simple
• C-Corp to an LLC or a C-Corp into an LLC is much more complex.
• Converting an LLC to a C-Corp
• Statutory conversion: Simple
• Filing a few forms with the secretary of state’s office
• Statutory merger: More Complicated
• Create your new corporation as a separate business entity before transfers
your LLC’s assets and liabilities to the new corporation automatically
• Non-statutory conversion: Most Complicated
*In reality, C-Corps are more easy to get funded

FORMINGANENTITYINDELAWARE
Even you are a California-based entrepreneur, we suggest that you start your business as a Delaware LLC or Delaware Corp.

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Less Expensive To Relocate The Corporation
If you incorporate in California and later move the corporation to a
different state, you still have to pay the $800 annual franchise tax each
year, but if you incorporate in Delaware and later move the annual
franchise of your “home state” where you initially incorporated could be
as low as $125.
Meet Angel, VC, and Investment Banker Preference
Angel investors and venture capitalists tend to prefer to invest in
companies incorporated as a C-Corp in Delaware. Many investment
bankers insist on a company being incorporated in Delaware before they
take it public.
Corporate Law Expertise of Delaware Court of Chancery
No corporation wants to be involved in litigation, but you would be glad
the dispute is resolved by a knowledgeable judge who is sophisticated in
resolving corporate law matters. Also, the extensive precedent of
Delaware corporate case increased predictability of the likely judicial
resolution of a business law dispute.
3 Reasons Why Delaware?

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Procedure of Forming an Entity in Delaware
• The fax number is 302-739-3812 
The mailing address is Division of Corporations -John G. Townsend Building - 401 Federal Street - Suite 4 - Dover, DE 19901.
• All corporations incorporated in the State of Delaware are required to file an Annual Report and to pay a franchise tax.
• The Delaware Division of Corporations allows for the reservation of an entity name. This is not a requirement in order to form your
entity but will guarantee that your name is held for you for a period of 120 days. https://icis.corp.delaware.gov/Ecorp/EntitySearch/
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Obtain a Registered Agent
Delaware law requires that every
business entity have and maintain a
Registered Agent in Delaware
Certificate for Filing
You may download a PDF fillable
cover sheet on our web site. at
http://corp.delaware.gov/
Submit the Certificate
You may submit the certificate either
by mail or fax. All filing fees must be
paid upon submission of your
request.
Other Information

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Status of Good Standing
You probably have to convert to the entity from one to another as your business grow
• Status of Good Standing
• Required Compliance: Appointing a registered agent, making timely filings of
required forms, and paying fees and/or franchise taxes.
• Business with “good standing”: keep all the rights and privileges of doing
business as a statutory entity.
• Typically, a Certificate of Good Standing is required in order to open a corporate
bank account, purchase or sell real estate, obtain a loan, obtain a Certificate of
Authority to operate in another state, or merge with another company.
• You may order a Certificate of Status or Certificate of Good Standing at the time
of filing your new entity by indicating this request in the comment section of the
Document Filing Sheet.
• Loss of good standing can damage your business

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Conclusion
While the choice of entity is really a case-by-case decision.
Generally, we suggest a startup starts from a “Delaware LLC,” which is the easiest and least costly to form. At the same time,
it generally with less tax. If all of the founding partners are U.S. residents or resident aliens, you may consider to start with a
S-Corp. You can enjoy pass-through taxation. Also, the investors generally prefer S-Corp over LLC.The fact that professional
investors want you to have a C-Corp does not mean that you need to form as a C-Corp initially. You may convert from the
LLC or S-Corp to C-Corp when you are about to receive Venture Capitals. (Both LLC and S-Corp converting into C-Corp are
not that hard.)
PARTNERSHIPS
Stage 1
LLC
SOLE
PROPRIETORSHIP
S-CORP
C-CORP
C-CORP
Stage 2 Stage 3

THANK YOU
Startup@BerkeleyLaw
Attorney: Kevin Xu
Email: khxu@berkeley.edu

Startup Basic #1: Choice of Entities

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