One of the most common, and tax efficient, entity types for startups is a Limited Liability Corporation (LLC). LLCs don’t have double taxation on profits and have much less paperwork when compared to standard C Corporations. Now, institutional investors will want to invest in a C Corp (or setup a blocker C Corp that then invests in the LLC) since they don’t want to deal with pass through entities as many of their investors are non-profits (e.g. large endowments and pension funds). LLCs have a governing document called an operating agreement that outlines the most core rules for the business.
Here are a few thoughts on the operating agreement:
- Take the time to get it right and agreed to by the co-founders
- Include scenarios like if a co-founders leaves the company under good and bad circumstances
- Incorporate how money invested or loaned by the co-founders is handled, especially when it comes to allocating losses (if applicable)
- Document what’s required to sell the company (e.g. can minority shareholders dissent or are there drag along provisions) as well as to buy or sell units (stock) in the company
Operating agreements are part of startup life for co-founders and should be drafted and implemented with the help of an experienced startup attorney (pay the legal fees for a good lawyer, it’s worth it).
What else? What are your thoughts on operating agreements and startups?