You have had an idea for the longest time. Maybe it started as something you kept talking about with friends, or something you noticed was missing in your daily life. After a few conversations with friends and family to test it out, you finally started working on it.

So far, things are going well. You have tested the product with friends, classmates, colleagues, and maybe even a few real users. The feedback has been encouraging. You may have even made a couple thousand dollars from it, which is probably more than you expected at this stage.

Now people are telling you the idea has real potential. They are saying more people need access to it and they are encouraging you to think bigger. So naturally, you start looking into what it actually means to build a company.

Your first stop is a podcast your friend recommended for “founders.” Twenty minutes in, you are more confused than when you started. You have heard LLC, C-corp, S-corp, QSBS, scaling, cap tables, SAFEs, convertible notes, Y Combinator, Techstars, and at least five other terms that sound important but are also very confusing.

Good news. You are in the right place.

In this series, we will walk through the early legal and business decisions that arise when you are trying to turn a promising idea into an investible company. The goal is not to turn you into a lawyer, but to help you understand what matters, why it matters, and what you should be thinking about before you get too far down the road.

Why does registering the business matter?
Right now, you are probably the business. The idea sits with you, the product sits with you, and the bank account, if there is one, may be yours. The contracts, if any, may be signed by you personally. In the early days, that may feel harmless because everything is still small and informal.

But once you start bringing in money, co-founders, employees, contractors, or investors, the business needs to have a separate legal existence. People putting money into the business need to know that their money is going into an actual company, not just to you personally. They also need to know that the company can own assets, issue equity, enter into contracts, and continue operating even if something changes with you as an individual. That is the main point of forming an entity because it gives the business a legal home. Once you get to that point, the next question is usually whether the company should be an LLC or a corporation.

What is an LLC, and why might it not be ideal for a startup?
LLC stands for Limited Liability Company. It is a flexible type of entity and can work very well for certain kinds of businesses. LLCs have members, and the rules for how the LLC is managed are usually set out in an operating agreement. For a small business, consulting business, real estate holding company, or closely held company that does not plan to raise venture capital, an LLC can be a perfectly good option.

The issue is that if you are trying to build a venture-backed startup, an LLC can become limiting pretty quickly. The main reason is that LLCs do not have common stock and preferred stock in the way corporations do. That matters because investors are usually looking to buy stock, and in particular, preferred stock. Preferred stock gives investors certain rights and protections that are standard in venture financing. You can structure investment into an LLC, but it is usually less clean and less familiar to the investors you are likely trying to attract. It can also make equity incentives for employees more complicated. While an LLC is not “bad,” it may not be the right structure if your goal is to build a company that can raise institutional capital.

C-corp or S-corp: what is the difference?
A corporation can be taxed as a C-corp or an S-corp. The difference matters more than it may seem at first. An S-corp has pass-through taxation, which means the company generally does not pay federal corporate income tax at the entity level. Instead, profits and losses pass through to the shareholders and are reported on their personal tax returns. That can sound attractive, and for some small businesses it is. But S-corps come with restrictions that make them a poor fit for most venture-backed startups.

First, an S-corp can only have a limited number of shareholders. Second, the shareholders generally must be U.S. citizens or permanent residents. That means if a foreign investor wants to invest in your company, you may have a problem. Third, an S-corp can only have one class of stock, which is a major limitation because venture investors typically invest through preferred stock, while founders and employees usually hold common stock. Finally, certain entities, including most venture capital funds, cannot hold shares in an S-corp, which creates a major issue. Venture capital funds are usually structured as limited partnerships and if they cannot legally own shares in your company, you have closed the door to a major category of institutional investment before the conversation even starts.

A C-corp does not have these same restrictions. It can have many shareholders, foreign investors, multiple classes of stock, and entity investors. This is why the C-corp is the standard structure for serious founders who are building for growth and outside investment.

In the next article, we will explore how a C-corp actually works, what your lawyer puts in place at formation, how equity is structured for founders and early employees, and why investors have come to expect this structure in every company they back.