[This is the latest column from Tubefilter News' resident new media legal expert, James C. Roberts. Last time he tackled reader questions on ownership of intellectual property in new media and online entertainment. This week readers wanted to know about where to set up shop, in the legal sense, when starting a digital media company. Also be sure to check out James' thoughts on the YouTube v. Viacom ruling last week and its effects on copyright protections in online video.]
Remember: Your mileage may vary, or to put it another way, these answers are not legal advice. How the law applies to you will depend upon the facts of the situation. Talk with a lawyer about those facts. In some cases, talk also with an accountant.
Q. I live in Los Angeles and I want to start a digital media company. I have heard that startups should be incorporated in some other state—like Nevada or Delaware. Does this make sense?
A. We usually advise California-based startups to incorporate in California if: that’s where their main office will be; that’s where their management and people (or most of them) will be; and/or that’s where the bulk of their business will be. Incorporating elsewhere increases burdens that a startup does not need.
Many people think that incorporating in certain states eliminates or reduces taxes. Not so. Incorporation in Delaware might reduce or eliminate taxes related to Delaware but not those related to California. If you incorporate in, say, Delaware but your office is in Los Angeles, you will still pay taxes in California as a “foreign” corporation (i.e., not incorporated in California). So “pay where you play” because you will have to do so, anyway.
Besides, incorporating in a different state at least doubles the paperwork—various filings for the state of incorporation and for the state(s) of operations. Raise your hand if you like increased paperwork.
If you’re not doing business in that other state, why would you care about its tax rates? In reality, most companies do most of their business in one state. A company will pay fees and taxes where it does a substantial amount of business. The meaning of a “substantial amount of business” can get your accountant all lathered up, and for good reason. (And yes, talk to your accountant and no, I am not one.)
Why Delaware? Why is Delaware so popular? It’s because—well, because it has been very popular for decades. In simple terms, it’s been something of a “herd” mentality—If others are doing it then so should I. Delaware was among the first states to simplify the incorporation process and lower state taxes. That’s what attracted companies in the first place. Other states responded so now the difference is not all that large.
Delaware incorporation has many benefits for large corporations, among them the vast body of corporate law. This legal resource benefits publicly-traded companies that have millions, if not billions, at risk in their legal wrangling. It is especially relevant in mergers, acquisitions and takeovers. Raise your hand if your startup will be involved in any such transactions soon.
Delaware corporate law is not necessarily a good thing for smaller companies. The statutes and case law can impose very high standards of conduct on management and boards that prove to be burdensome, especially for startups. You can scare away potential board members. In addition, lawsuits relating to Delaware law can be very, very expensive.
And Nevada? The Nevada tax rates are certainly enticing but a company doing business in LA faces the same issue it has with Delaware incorporation: There is no real connection. There is also the matter of perception. The state has something of a checkered past in stock manipulation and other questionable corporate activities. That view may well be wrong but it still has its effects, especially if you seek outside investment such as venture capital.
If and when the LA-based startup starts doing a substantial amount of business in multiple states then it would make sense to consider re-incorporation in another state. Re-incorporation is relatively simple. As a startup, you’ve got more important things to do. Do those things. Now.
Q. I am thinking about starting up a company to develop digital content. What form should I use?
Startups usually take the form of a “C corp,” an “S” corp or a “limited liability company,” known as an LLC. Usually, it comes down to a choice between a C corp and an LLC. There are benefits and drawbacks to each, but first, a few basics of these two forms.
All of these legal forms limit the liability of the owners—those who form the corporation. This is the main reason for having such a structure. The main differences are taxes and corporate formalities. A C corp. pays taxes at the corporate level, as do the shareholders for dividends, while the other two forms “pass through” their taxes to the owners. A C corp also has to follow fairly specific requirements as to its structure—it must have a board of directors, bylaws, regular meetings and corporate minutes. Failure to follow those formalities can result in the loss of the limited liability. LLC’s, on the other hand, have fewer such corporate formalities. Typically, these is no board required.
Which form you use comes down to your goals. Venture capitalists prefer a C corp structure, but worrying about that now may be unnecessary. A conversion or other restructuring can take place if the venture capital investment becomes a reality.
These days, most new companies in the digital media & entertainment space are LLCs because of their simpler corporate structure. Most loanout companies in Hollywood these days are also LLCs. In most cases, the LLC serves the basic purposes needed for a loanout, especially if the company will remain small.
This is one of those issues that really requires some input from a professional—usually it is best to start with an accountant.
James C. Roberts III is the Managing Principal of Global Capital Law Group and CEO of the strategic consulting firm, Global Capital Strategic Group. Between the two groups there are offices in California, Colorado, the East Coast, Shanghai and Milan. He heads the international, mergers & acquisitions and transactional practices and the industry practices concentrating on digital, media, mobile and cleantech technologies. Mr. Roberts speaks English and French and, with any luck, Italian in the distant future. He received his JD from the University of Chicago Law School, his MA from Stanford University and his BS from the University of California Berkeley. Have a question? Email James
This ‘Ask the New Media Attorney’ post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented without seeking the advice of counsel in the relevant jurisdiction. Tubefilter, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.