The 9 Least Sexy Parts of Starting a Tech Startup
By: Jonathan Woahn
Tags: Entrepreneurship, Life Lessons, Founders, Startup Lessons, Startup

The 9 Least Sexy Parts of Starting a Tech Startup

Starting a business is all fun and games until the IRS and legal work get involved. Then it sucks. Best know what you’re getting into.

In the summer of my second year of college, I started an IT consulting business with a good friend. Given we were both IT experts, it seemed like a great idea.

Problem was, neither of us had started a business like this from scratch. It was an eventful ride, but the TLDR version is due to our inexperience, the IRS believed we owed $60k in taxes.

It took 2 extremely painful years to convince them we didn’t (the business went belly up, and we lost money).

The entire debacle could have been avoided if we’d only know what we were getting ourselves in to. The ugliest parts of starting a startup are by far the legal and tax aspects. But people rarely talk about them, and nobody hands you a “how-to” guide when you decide to start your business.

Get this part right, and nobody will ever know or think twice about it. You’ll never get a pat on the back or an “atta-boy” (or girl). Get it wrong, and people will curse your name for generations. You’ll create years of headache for you, your founders, your investors, and just about everyone involved in the business.

So get it right.

This document is for anyone planning to launch, or in the process of launching their first startup. Think of this article as a guide on what must happen in order for you to cut the first paycheck for your first employee — even if that employee is yourself.

It takes much, much longer than you’d anticipate, so best get going.

1. Naming your business

This is more than making sure you check all the marketing requirements (great domain, memorable, on-brand, etc.). You need to figure out the legal entity name of your organization, and it doesn’t have to correlate with the name that you do business under.

While it’s great if it does, it definitely isn’t required. What it does need to be is unique, particularly in the state where you file as a domestic entity (more on that shortly).

This is kind of a big deal, so I’m going to reiterate this in different words in case you missed the real message.

Don’t hold up the legal formation of your business just because you haven’t figured out the perfect name for your company.

Finding the right marketing name can take months, especially if you’re hell-bent on finding a great “.com” domain to go with it. Instead of waiting for celestial inspiration, figure out something good enough you can do business under right now (do a quick entity search with the USPTO and your filing state’s division of corporations), and register it.

If the legal entity name is not the same one you ultimately do business under, you’ll want to register as a DBA (Doing Business As) in the states where you conduct business.

2. Determining the type of legal entity

There are many legal entity types to choose from, but only 3 that make sense for most people.

As mentioned, I’m not an attorney, I won’t get into the details of each entity. But from an entrepreneurs perspective, selecting a legal entity boils down to 2 factors: taxes and fundraising.

LLC

Taxes: Profits and losses flow straight through to the owners. You will claim profits as income, and losses as, well, losses.

Fundraising: Not investable by venture capital, for a lot of reasons. The tax implications for many VC’s will deter, if not outright prevent them from being able to invest in LLC’s. There’s also the non-legal issues, like the inability to create different classes of stock and how to handle liquidity events like an IPO. It gets complicated.

When to choose this structure?: If you don’t plan to take on venture funding and you want to get something simple up and running quickly, it’s a good choice.

C-Corp

Taxes: Lots of them. C-Corps get hit with taxes both coming and going. When the company turns a profit, the company has to pay taxes on it. When it disburses profits to shareholders, those profits get taxed. When it pays employees, the employees pay income tax and the C-Corp matches payroll taxes.

Fundraising: Basically if you’re planning to take venture capital, you’ll need to convert to a C-Corp. Not only can C-Corps create different classes of stock (i.e. preferred v. common), they can do option pools and other incentive plans. Lots of options here.

When to choose this structure?: If you’re planning to raise venture capital, choose this structure. However, if you have some time before that happens, you can always start with an S-Corp…

S-Corp

Taxes: Taxed similarly to an LLC, where profits and losses pass through to the shareholders. When the company makes a profit, the corporation doesn’t need to pay taxes on it — only the shareholders.

Fundraising: S-Corp’s have a lot more options when it comes to fundraising compared to an LLC, however, there are some limitations that if violated, will automatically revoke an S-Corp election. For instance, if there are more than 100 shareholders, more than 1 class of stock, or an ineligible shareholder, such as another corporation. Any single one of these conditions will revoke the S-Corp status.

When to choose this structure?: If you’re planning to raise funding in the future and you have at least one tax season before doing so, it can be helpful for founders to start as an S-Corp. Revoking an S-Corp election is quite simple, you just need to make sure the IRS recognizes the change in status

PRO TIP: always communicate with the IRS via certified mail so you have a paper trail. And then file it away and don’t lose it. The IRS is notorious for losing paperwork. Just assume you’re going to have to prove to the IRS you sent every document you actually send them.

3. Designing your cap table

There are so many great resources already written on this, I won’t dwell on this one long. I include this section mainly because it is required for you to file your Articles of Incorporation, and it’s a meaty conversation you need to start thinking about now. A couple of excellent resources to help facilitate the conversation.

If you’ve never dealt with a cap table before, this article is a great resource explaining the fundamentals of what a cap table is and the terminology/concepts associated with how they work. It’s also pretty technical, so feel free to reach out if you have any questions.

The next question to consider is how you are going to split equity with your cofounders. There are strong opinions on how to approach this, ranging from split it equally and make sure everyone is equally yoked to proportional to the value a person brings to the team.

I tend to lean toward 50/50 in ventures with 2 founding partners and proportional in teams with more.

Finally, consider the optics and narrative your cap table is sending to the world. It’s important to think about these issues from the beginning so you make sure your company is in the best possible position of where you want to be when you reach your future milestones.

4. Generating your Articles of Incorporation

Now that you’ve determined the legal name of your company, what type you want to create, and how you want to split your cap table, it’s time to formalize everything.

There are handful of ways to go about doing this — utilizing free services like Cooley Go’s online document generator, services like Clerky or Gust, or find a lawyer/firm to work with (many of them have startup packages) — are pros and cons to each.

Once you have your attorney, treat them like a member of your team. CC them when you send out company updates or when you’re discussing terms with investors, bcc them when you’re negotiating partner contracts to help keep them up to date, invite them to your board meetings and go to lunch (odds are they’ll pick up the tab). The right attorney won’t bill you for many of these things, and in the end, will thank you because it helps them have context when it’s time to move.

One step I skipped here is selecting which state to incorporate in. Yes, there are actually legitimate reasons to incorporate in states other than Delaware — like Nevada doesn’t have a corporate income tax or annual franchise tax. But most likely you’re going to incorporate in Delaware.

Whatever route you go to generate your founding package, the respective path will help guide your next steps. Except maybe the free ones — you’re likely going to stumble a bit as you figure it out, and you’ll learn a lot in the process.

5. Filing an SS-4

This is the equivalent of getting a Social Security number for your business, and it’s called an Employer Identification Number (EIN). You’re going to need this for everything. There’s an online application where you can apply for and receive your electronic EIN on the same day.

It’s fairly painless and pretty quick to do — so just get it done as soon as you’re ready.

6. Registering as a foreign entity

I rewrote this section 5 times, trying to figure out how to make it most helpful — and ultimately, it came down to this.

Get a great accountant to go along with your awesome lawyer.

Here’s the deal. You’ll incorporate your company with a specific state, but then you have to register as a foreign entity in the states where you’re doing business for three key things: 1) Income tax 2) sales tax and 3) payroll tax. Your attorney and accountant can help you navigate all of these — the attorney on the legal side, the accountant on the regulation side.

The most important thing for you to know is — you need to register as a foreign entity in states where you have W2 employees as soon as you possibly can. Registering will provide you with an Account ID and a Withholding Account ID, both of which will be required for you to run payroll and handle payroll taxes.

It can take weeks, even months for some states to get this information, so if you anticipate paying salaried employees, this will be your bottleneck.

7. Filing your 83b

The IRS is like a hawk — they watch your every move, waiting for you to make a mistake so they can swoop in and eat you for lunch. More than anything, they want to make sure Uncle Sam gets his cut of anything that could potentially be considered income.

Your founder shares fall squarely in that category, and the 83b is how you protect yourself.

Basically, the 83b declares to the IRS that you received shares at the foundation of the company and they shouldn’t be seen as regular income, but rather an investment (and should be treated as such). You shouldn’t have to pay taxes on them until you cash out.

However, if you fail to file an 83b, the IRS will see your shares as income as they vest, and you will be taxed under the appropriate tax bracket. In reality, it’s not like the IRS will track you down and make you pay taxes as they vest, but when a conversion event comes into play or you realize the 83b election hasn’t been made and you declare it to the IRS, you’re going to get a hefty tax bill, whether or not you’ve actually made any money from your shares.

I always find examples helpful, so consider the following.

Assume you start a company, you own 50% of the shares in the business, are on standard vesting terms (12-month cliff, 48-month vesting period), and you forget to file your 83b.

2 years later, you raise a seed round with the company valued at $10MM, and you now own 40% of that business. Technically, your position is valued at $4MM, and since you’re 2 years in, half of your shares have vested.

If the IRS were to find out, you’d owe them taxes on $2MM of ordinary income — even though you haven’t actually made a dime. On a startup founders' salary, owing hundreds of thousands in back taxes on money you haven’t actually made yet is going to put you into a world of hurt.

File your 83b (via certified mail, of course!). You have 30 days after the initial grant to do so.

8. Setting up a bank account

You can get a business bank account just about anywhere, and depending on the nature of your business, you may have specific considerations in what you’re looking for.

Initially, the factors I’ve found are most important are:

How fast you can get started/approved/moving How much it costs Ability to move money (checks, ACH, wire transfer, etc.)

There are other factors you may want to consider later on like bill pay, API access, access to capital and banking advice, business loans, etc.

Two great options for startups are SVB and Mercury.

Ultimately, you may end up going with SVB — they have excellent services for startups and can help you grow all the way to exit. SVB gets involved much more than just being a bank, they have connections everywhere, and their team can help provide financial guidance as you grow. I’ve found them to be extremely helpful.

However, if you’re just getting started and need to move quickly, I can’t recommend Mercury enough. You can open an account completely online without having to speak with a person in minutes, and they provide exactly the right services you need as a startup, and nothing more. They’re fantastic.

They have money movement features available immediately, but you can create new accounts dynamically, issue and cancel debit cards to everyone on your team, track expenses, transfer money between internal and external accounts, and they have a great user experience.

Oh yeah, did I mention it’s free, with no minimum balance required?

Start with Mercury.

9. Setting up payroll software

Payroll is a joy. When you bring new employees on, not only will you have to collect I-9 and W4 information from them (and yourself), you’ll also have to file forms 940, 941, 944, and anything else the IRS and state departments come up with.

Instead of waiting for the penalties to roll in before learning what needs to be done, do yourself a favor and just sign up for payroll software. It’ll make your life much easier — unless you make the wrong choice.

Quickbooks and ADP are two common choices/big players in the space. Quickbooks does a good job for early stage companies until you have to start streamlining your HR/onboarding processes further, and it breaks down around integrating benefits (I think they’ve recently addressed this, but I don’t have any experience I can speak to).

That’s where ADP supposedly shines. It’s the 800-pound gorilla in the HR space and can do just about anything and everything you can dream of for your corporation of thousands of employees. But honestly — I hate it. I’ve never had a worse user experience than I have had in trying to administer ADP, and it’s way more than you need with a small company. Avoid ADP like the plague.

My suggestion? Go with Gusto. They have a phenomenal user experience, they’ll handle collecting and filing all the forms I mentioned above, and their benefits platform continues to grow. Your employees will love you.

I’m a huge fan of their platform, and I recommend them to everyone who will listen.

The final word

Starting a business is hard enough without having the figure out the administrative legal side of things. My experience in every step of this document only came through me literally tripping through each stage.

Learn from my missteps, and hopefully, it can help you get up and running even faster.

Remember, do it right, and nobody will ever thank you for it :D