Creating a Legal Entity

This is not legal advice

Sooner rather than later, as a business you need to establish yourself as a legal entity. This marks a major milestone! Only once your company legally exists can you pursue licensing to produce and sell your product. It is also a good idea to incorporate so that you can enter into contracts and nondisclosure agreements with designers, food labs, and other contractors you might encounter early on in your development process. Forming a corporate entity will also grant you protection from some legal liability.

Deciding what form of legal entity to take is a significant decision. Most food companies exist as either an LLC or a corporation. Both of these structures allow you to pursue everything you need to get on store shelves, but they have notable differences. We break down some of the differences below, but you should talk to legal and tax advisors as you make this decision. 

As an LLC, partners (you and your co-founders) receive membership interests in the company that are synonymous with shares in a corporation. LLCs are not formally recognized by the IRS for tax purposes, so you must opt into tax treatment either as a passthrough entity or as a corporation; by default, the IRS will treat your LLC as a passthrough entity. As a passthrough, profits/losses for the year are allocated to the LLC’s owners, to be included on your individual tax returns. If you choose to be taxed as a corporation, your company will file its own returns. Note that corporations face double taxation, meaning that as a corporation you pay taxes and profits distributed as investment income to shareholders get taxed as well. LLCs are typically easier and cheaper to establish than corporations. While increasingly common in the startup space, LLCs are slightly less common in financing arrangements and some investors might prefer a C-corp structure. 

As a corporation, ownership is determined by stock holdings in the company. When you form your corporation, you determine how many shares to issue and to whom. This structure is recognized by the IRS, so you file taxes as a corporation, and face the same issue of double taxation mentioned above. If you choose this approach, you should work with a lawyer to file an 83(b) election to avoid an unpleasant tax burden later on as your shares appreciate in value. 

Depending on where you incorporate, you may also have the option to become a low-profit limited liability company (L3C) or a public benefit corporation (PBC). An L3C functions like an LLC but with additional requirements to communicate and pursue a social mission, while a public benefit corporation is like a corporation but also with additional mission-based requirements. These legal structures allow you to embed your social mission into your company’s DNA, which can be attractive to customers, employees, and investors. They also may offer legal cover from shareholder primacy (the idea that you must pursue profits above all else), although this is a developing field in law. Each state has its own rules governing which legal entities are permitted, so it is worth considering this decision in hand with where you choose to incorporate. 

If, months or years after you incorporate, you realize you want to change from an LLC to a C-corp, this is possible for additional fees. Each state has its own rules and regulations regarding reincorporation and asset transfer, and if you are reincorporating from one state to another you need to make sure both states allow for the reincorporation process you are pursuing. Since reincorporation involves additional costs and complexity, you should do what you can to make an informed decision that will work for your company over the long run.

Beyond choosing a legal entity, you also need to decide where to incorporate. Many companies choose to incorporate in Delaware because Delaware’s Division of Corporations is highly professionalized and because so much case law has been established that Delaware companies perceive regulatory stability (this means your corporate lawyers will know exactly how the law works and you’ll have few surprises). Another logical choice is to incorporate where you live. If you incorporate in a state other than where you (and your employees) reside and operate the business, you will need to register in those states as well.