# Formation and structure

## Not legal advice; escalate when

This skill explains common entity and ownership patterns. It is education, not legal advice. Escalate to counsel any time equity is being granted, co-founder splits are being formalized, or the business will operate across more than one jurisdiction. Cap-table math routes to the numbers specialist; the legal binding of it routes out.

## When to load this mode

The user is forming a new entity, splitting ownership with a co-founder, granting equity, or trying to understand which entity type fits their plans. Load when they ask "LLC or C-corp," "how do I add my co-founder," or "do I need to incorporate in Delaware."

## Procedure

Five checks, in order.

**1. What is the business doing in the next 12 months?** Entity choice flows from this. The same person needs different entities for "I freelance design work" versus "I want to raise venture money" versus "I run a corner shop with my spouse." Get the 12-month picture before naming an entity.

**2. Match the situation to one of four common patterns.**

- **Sole-prop or single-member LLC.** Solo operator. Service or simple product. No outside investors planned. LLC adds liability separation and modest tax flexibility for low cost.
- **Multi-member LLC.** Two or more owners. No outside investor plans. Co-owners want flow-through taxation and operating-agreement flexibility. Requires a written operating agreement before money moves; without it, default state rules apply and the owners may not like them.
- **S-corp election (not entity type).** Layered on an LLC or state corporation. Useful when the owner draws a salary and wants to reduce self-employment tax on profits above it. U.S.-only, U.S.-resident-owner-only, with shareholder-count limits. Talk to a CPA before electing.
- **Delaware C-corp.** The default when the plan is to raise outside investment. Standardized law that investors expect. Costs more to maintain (franchise tax, registered agent, separate tax return) and is taxed at the entity level. Pick this when you are raising, not because it sounds professional.

**3. Pick the jurisdiction.** Delaware for C-corps that will raise. Home state for LLCs that operate locally. Operating-in-State-A-but-formed-in-State-B almost always requires foreign qualification in State A — which costs money and erases the supposed advantage.

**4. Document the ownership cleanly.** Even with one owner, the entity should have a written formation document (operating agreement for LLC; bylaws + board resolutions + stock-purchase agreements for a C-corp). With more than one owner, the agreement must cover: ownership percentages, vesting (typically 4-year vest with a 1-year cliff), drag-along and tag-along, what happens on death/disability/departure, how new equity gets issued, and how decisions get made.

**5. Don't issue equity in fractions you didn't intend.** Common founder mistake: "we'll just split 50/50 and figure it out." Six months later one founder leaves with 50% forever. Vesting solves this. Another: handing out "10% of the company" to an advisor verbally, then realizing 10% of common stock has tax consequences. Equity is real; treat it like it.

## Decision rules

- **Raise or no raise?** If no raise is planned in 24 months, LLC is the default. If a raise is planned, Delaware C-corp.
- **One owner or many?** Many owners means an agreement before money moves, every time.
- **Vesting on day one.** Every founder share, every employee grant, every advisor share. No "we trust each other" exceptions.
- **Form in the state you operate in,** unless you have a specific reason to form elsewhere.
- **Convert later if needed.** LLC-to-C-corp conversion is a known move and your future investor's lawyer has done it many times.

## Anti-patterns

- **Forming a Delaware C-corp because it sounds serious.** Franchise tax for nothing.
- **Co-founder splits without vesting.** A walk-away co-founder with unvested equity is a problem for life.
- **Issuing common stock to advisors without a 409A valuation.** Tax problems for both sides.
- **Operating as a sole-prop while signing big contracts.** Personal liability the entity would have separated.
- **Skipping the operating agreement "we'll write it later."** Default state rules will fill the gap and you will not like them.

## Before / after

**Before:** *Two co-founders form an LLC, split 50/50, no operating agreement, no vesting. Eight months in, one leaves for a job. The remaining founder owns half a company with someone who has no involvement.*

**After:** *Same two co-founders, operating agreement signed, 4-year vest with 1-year cliff for both, buy-back on departure at the original $0.001 share price. One leaves at month 8 — buy-back triggers, the remaining founder owns the company outright. Cost: about $1,500 up front.*

**Disclaimer:** I am not your lawyer. This is a framework, not legal advice. For entity choice, jurisdiction selection, drafting your operating agreement, and any equity grant, you need actual counsel.
