Formation & Entity Structure: Important Considerations for Startups

Decisions, decisions!

Businesses often wonder where to start in connection with pulling together corporate paperwork for initial operations, including as to how they should structure their businesses and what entity type to choose.

Many new entrepreneurs don’t have a broad understanding of how different types of entities operate and why it’s important to consider a variety of factors when choosing a preferable business structure. There are multiple considerations that come into play when determining what business entity type to choose, including:

  • tax and related liability concerns;
  • future business goals;
  • growth strategies or multi-state considerations;
  • potential investor preferences;
  • compliance and regulatory considerations;
  • and other matters.

Based on these important considerations, some founders choose limited liability companies (LLCs) while others prefer a corporate structure.

Limited Liability Companies (LLCs)

Frequently individuals who have previously worked with a certain entity type structure prefer to maintain that kind of structure because of their familiarity with that type of entity structure. For individuals with a history of smaller operations, we often see them choose to work with limited liability companies.

LLC Operating Agreements

The interesting thing about LLCs is that they offer flexibility in terms of management decision-making, financial matters, and corporate governance in general, with a single document called an “operating agreement” dictating nearly all terms of how the entity operates. The operating agreement sets forth the governing terms of the LLC, such as terms around voting, control and management of the LLC, sale and dissolution of the LLC or LLC assets, among other terms.  Operating Agreements can take all different shapes and sizes and account for different rights and management approaches in a lot of unique and deeply negotiated ways. Similar to corporate boards of directors, discussed below, the operating agreements can make all of the member participants (equity holders) managers or, in the alternative, can set a board of managing members or certain managers for special decision making for the LLC.

Potential Complications and Important Tax Considerations for LLCs

Sometimes this wide variety of structures can complicate a new LLC construct with various partners that come together but previously worked in a variety of different LLC structures historically. Still, many choose LLCs based on certain tax considerations or because of familiarity with LLCs and a fear of corporate “double taxation” (taxation at the entity and personal levels).  However, these tax considerations should be discussed in some depth with tax professionals when choosing an entity type and including potential mitigating factors with respect to tax liabilities.

Corporations

Unlike with LLCs, corporations tend to follow a more uniform approach to operations (at least at the early stages, e.g. with respect to corporate bylaws and corporate certificates or articles of incorporation). There are relatively standard deviations that corporate governing paperwork tends to take (although shareholders may also negotiate certain unique shareholder agreements).  

In some ways the corporate construct constrains itself to being more structured with a gold standard available for things like preferred financings (e.g. see NVCA.org). For example, corporations have a board of directors that makes decisions for the company (and then certain decisions also require shareholder approval). Keeping decision making at the board level rather than at shareholder level (unless necessary) can keep things streamlined and efficient. (If a limited liability company is managed by the members and there are numerous members this can be more difficult and the limited liability company should consider instead becoming manager-managed.)

Compliance and Tax Considerations for Corporations

As mentioned above, among certain governance differences, there are also tax differences between the corporate and LLC structure to consider. Further, compliance factors should also be considered with respect to business structuring or business restructuring in the cannabis industry. It’s important to always be cognizant of if an entity type change or certain corporate structure or restructure could either create additional compliance risk going into the compliance process or risk forfeiture of a permit or license if the organization is already permitted or licensed or has commenced the application process.

Other Options and Variations in Structuring

Often founders choose between LLCs or corporations (though other structures are also available).  Some founders decide to initially start their business out as a limited liability company and then convert into a corporation. Others will maintain the structure initially selected for the life of the business. Other entities take different paths. Some entity structures have the ability to easily change entity type and other structures may not be as flexible to restructure (especially if certain compliance or regulatory restrictions might apply to changes of entity type, such as in connection with certain licenses or permits). Some businesses choose to be part of a larger group of companies, setting up holding companies or management companies, whereas others operate as stand-alone operations.  There are a variety of options to discuss in connection with the specific facts applicable to the business and the business intentions of the executive management of a company.

We Can Help Guide You

At Rogoway Law Group, we have a one stop shop to address these various questions and concerns with respect to transactional, tax and compliance matters and corporate structure. We have corporate attorneys that work regularly on formation matters and tax counsel to advise on related tax concerns.  At each step of the way our corporate team works closely with our compliance team to ensure no missteps are taken when it comes to corporate formation or reorganization and restructuring.  We are happy to work with you to learn about your specific goals and how we can assist in facilitating them.

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