Type of Entity for Investment

If you plan to seek investment, the preferred entity of most investors and VC's is the C corporation, which is the standard corporation formed by incorporating. Limited Liability Companies, Limited Partnerships and other entities are not favored due to the variation in rules between states and because they do not have the legal structure of shareholders, a board of directors and officers which are standard components of investment.

If you have less than 75 shareholders, you'll probably want to elect to be an S corporation for tax purposes. You must file the election form 2553 within a short time after incorporating, so be sure to check with the IRS regarding the filing and the deadlines. If you need to expand beyond 35 shareholders in the future, you can change your tax status back to a C corporation to do so.

Who Plays What Roles In a Corporation

If you have created a corporation with an eye toward investment, it's important to become familiar with the various corporate roles.

Board of Directors

The original Directors are designated in the Articles of Incorporation which is the document filed with the state to legally form the entity. Directors oversee the Officers of the company and assure that it operates according to law and corporate procedures. Directors have a fiduciary duty to the corporation to act in the corporation's best interest, not to their own best interest, among other legal duties. These duties are to protect the shareholders' investments in the corporation. Investors often want at least one representative on the Board of Directors since the Board formally controls the decisions of the company. However, sometimes investors avoid having any directors and arrange other contractual alternatives in order to avoid the fiduciary duty requirements to act for the benefit of the corporation rather than themselves. The Board of Directors appoints and may fire the Officers of the corporation who are responsible for the day to day operations of the company.

Shareholders

Shareholders are persons who have been granted stock by the corporation in exchange for money paid or services performed for the corporation. The shareholders meet annually, at the corporation's annual meeting, to elect the Board of Directors. Shareholders are not financially liable for the debts of the corporation and are not legally liable for any wrongdoing of the corporation. Investors will be granted shares in exchange for their investment. Typically, they will want "preferred shares" which mean that if there are minimal dividends or other negative financial events, they will have priority in getting their money over the "common stock" shareholders.

Officers

Officers typically include at least a Chief Executive Officer and/or President, Secretary and Treasurer/Chief Financial Officer. Officers do not have the same heightened level of fiduciary duties to the corporation that the Board of Directors has.

Conclusion

Any time you are dealing with investor related agreements and stock grants, you'll want to have a securities attorney to work with. These areas are complex and vital to being sure that you retain control and future benefit from your company. As a side note, the attorney you work with usually should not be a shareholder or board member of the company. If he or she suggests this, then be sure to discuss the Professional Responsibility Rules of his or her State Bar with the attorney and/or phone the State Bar attorney complaint line to discuss the situation and be sure his or her actions are ethical.