If I Launched a Startup - Cheat Sheet

1. A Delaware C-corp is often a fine choice for startups but be careful not to make it a fixed rule. Whatever you do must fit your circumstances and not be something you do simply because it is declared from on-high. You don't want to find yourself in the position of the young founder who ultimately said "why incorporating my startup [in Delaware] was my worst mistake" (see http://news.ycombinator.com/item?id=2399139). And, as tptacek points out variously on this thread, sometimes an LLC or an S-corp might be a better fit for you or your team - this choice is often tax-driven, though it can also tie to the less formal management structure and the often lower cost of an LLC (see my comments here on some pluses and minuses of LLCs in a startup context: http://news.ycombinator.com/item?id=1276724). My point: think it through before making this choice (on domicile, here are some thoughts on how local domicile might in some cases be better than Delaware: http://grellas.com/faq_business_startup_002.html).

2. C-corp is a particularly good choice for 2011 if you plan to hold the stock in your venture for more than 5 years with the hope that you can sell it free of any federal capital gains tax and also free of AMT. Not all stock grants will qualify, even in a C-corp, and so you should check with a good CPA (for some of the relevant factors, see my comments on so-called QSB stock: http://news.ycombinator.com/item?id=2018041).

3. Vesting for founders is a mix-and-match process and does not have to be uniform for all founders. Those who have not yet make significant contributions to a venture at the time of entity formation normally should take their interest subject to vesting - otherwise, they might walk away with a large piece of equity before having earned it. This wouldn't necessarily apply to all founders, however, and it is at times appropriate that one or more founders on a team get their stock (or at least a significant part of it) free and clear of vesting requirements. Otherwise, there is an unfair risk of forfeiture placed upon them. Also, the one-year cliff idea often doesn't fit with founders, in my experience; more typically, there is some sort of immediate pro-rata vesting (monthly, quarterly, etc.).

4. The "lock down the IP" point is often overlooked, especially by founders trying a DIY approach: make sure you have not only technology assignment agreements to capture all IP generated in the pre-formation stage but also invention assignment / work-for-hire agreements to make sure the company owns all IP generated by founders after they have their initial stock (the company does not automatically own it just because they are owners doing work on the venture). The idea of IP has its detractors today but your company will suffer in fund-raising and on exit if holes exist in these areas. All it takes is one bad episode - anything from a founder bolting to form a directly competitive venture using the same IP to an ex-founder filing suit to block further company development on IP that he claims he owns - to convince most founders that IP protection is in fact vital in the early-company stage for most ventures.

5. One other very important item: make sure to separate your founder grants from any large cash investments that are done for equity. If you don't, it will create tax risks because, if cash and services are contributed for stock at the same time and for the same type of equity, the service providers (i.e., those contributing the "sweat equity") can potentially be taxed on the value of the equity received as measured by what might be a high company valuation (e.g., you get 50% and an investor gets 50%, you contribute your talents and services and the investor puts in $200,000, all for common stock - result: you are at risk for having received up to $200,000 income item on which you must pay tax). Not a particular tax risk if investors use convertible notes (because the stock is not priced in that case) but a potentially serious one if investors get stock. The relevant planning tip: while you don't need to unduly front-load expenses, don't wait too long before setting up the entity either - you should generally do this before you have your investors lined up and about to sign.

The S-Corp in particular has some attractive features: it simplifies equity grants to employees compared to an LLC, and taxes are easier to deal with in a C-Corp (there's also a sort of notorious salary-vs.-distribution trick people place with S-Corps to reduce their taxable income).

The LLC is incredibly easy to set up; you can probably get one via 1-click on Amazon now.

In the only company I founded that took serious VC, I didn't handle any of the legal, but the sense I got was that legal for a real VC round is so innately expensive that the S-to-C conversion isn't a big deal by comparison. It's most convenient for everyone if you're not even incorporated, but that's their problem (it is dumb to do business without incorporating); if you're worth funding, nobody is not going to fund you because of the cost of converting to their preferred structure.