Pankaj Raval (00:16)
Hey everybody and welcome back to Letters of Intent. I am Pankaj Raval, the founder of Carbon Law Group. And today I am joined by my fantastic co-host, Sahil Chaudhary. Sahil, how are you?

Sahil (00:25)
I’m doing great. I am, yes, for everyone who doesn’t know me, I’m Sahil Chaudhary. I’m corporate attorney here at Carbon Law Group. And today we have a special episode of Letters of Intent. Today we’re going to be doing some role playing. And yes, you heard that right. This is not an OnlyFans channel. We are going to be doing some legal role playing where I’m going to play lawyer and Pankaj is going to play And we’re going to try to figure out whether he should select an LLC or C Corp for his new

Pankaj Raval (00:33)
We have

Today we’re going be doing some role playing and yes, you heard that right, it’s not an OnlyFans channel. We’re going to be doing some legal role playing where I’m going to play Funkage is going to play we’re going to try to figure out whether he should select an LLC or C Corp for his new

Yes, I’m going be putting on the I’m going to be asking a lot of questions that probably you guys have.

listeners out there when you first think about starting a business. So, Sahil, should we jump right into it?

Sahil (01:02)
jump right in. So Pankaj, first of all, what kind of business are we talking about? Let’s aim first at industry. take any example that maybe from a client you’re working on right now, what’s an industry we should explore?

Pankaj Raval (01:15)
start with maybe healthcare, right? Because this is an issue that we’ve dealt with recently. A client comes to us and say, hey, I want to set up a sober living practice or sober living company and I need to figure out how to structure this.

Sahil (01:28)
great. Well, when it comes to anything that has a professional element to it, where there’s an added element of complexity, which is that in a professional corporation, you cannot have someone non-licensed owning a piece of that business. Now with sober living, we understand there may be exemptions there, but coupled with any kind of professional corporation is usually a management services organization, a company that’s intended to distribute

Pankaj Raval (01:30)
to any

there’s an added element of complexity, which is usually in a professional corporation, you cannot have someone non-licensed owning a piece of that business. Now with Sober Living, we understand there may be exemptions there, but coupled with any kind of professional corporation is usually a management services organization, a company that’s intended to

Sahil (01:56)
profits that is meant to invoice, that’s meant to provide the administrative support to

Pankaj Raval (01:56)
profits, that is meant to invoice, that’s meant to provide the administrative support.

Sahil (02:01)
a professional corporation. So Pankaj, let’s try to, what I would suggest is we’re going to start with focusing on that organization and then we can figure out what would be the right entity.

Pankaj Raval (02:01)
a corporation. So, let’s what I would suggest is we’re gonna start with focusing on that organization and then we can figure out what would be the right

So let me tell you little bit more about the business and what we kind of do. So the hope so I’m a physician and I’m gonna be providing the actual clinical care for a lot of these people going through these withdrawal, going through elements of becoming sober.

I’m working with this team of people. about four of us and we want to be able to structure it in such a way that we can grow it and ideally get investors in the future. We really want to make this into a large nationwide organization. We see the benefit of it. We see we can make a great impact, we can help a lot of people. I’ve already proven it out on them this last year, but now we need to figure out how do we best structure this for growth and also making it attractive to investors.

Sahil (02:48)
let’s start with, there are different kinds of businesses. Sometimes people open up a business for cash flow and sometimes people open a business because they want that big juicy exit. And so in this case, are you expecting the business to distribute profits to its owners regularly?

Pankaj Raval (02:50)
different kinds of businesses. Sometimes people open up a business for cash flow and sometimes people open a business because they want that big juicy So in this case, are you expecting the business to to its owners

So, the question, I think I’d like to get paid, for my time. I’d like to make sure I’m properly compensated. But as far as distributions go, I mean, I have another job. the bills are paid. I’m not looking for

massive distributions or profits taken out from this company. I really want to see it grow. I really want to kind of reinvest that money so we can, we can scale this thing into something much, much larger. So if your goal weighs in favor.

Sahil (03:24)
So if that’s your goal, weighs in favor of

an LLC versus a C Corp. And I’m going to explain why, because at the end of the year, an LLC is taxed on the profit that is allocated to each of the members of the in a C Corp, the entity, you’re taxed at the entity level, but then you’re only taxed on the dividends that are actually distributed to the owners of the C Corp.

Pankaj Raval (03:30)
explain why because at the end of the year an LLC is taxed on the profit that is allocated to each of the members of the in a C Corp the taxed at the entity level but then you’re only taxed on the dividends that are actually distributed to the owners of the C

Corp so if you aren’t expecting to get regular distributions it’s better for you to go with the C Corp

Sahil (03:49)
So if you aren’t expecting to get regular distributions, it’s better for you to go with a C Corp

because that way you can retain earnings within the company instead of having those, instead of having the cash go out to the owners regularly and deplete the reserves in the business.

Pankaj Raval (03:55)
Because that way you can retain earnings within the company instead of having of having the cash go out to the owners and Deplete the reserves in the business

Interesting interesting. Okay. So you’re saying that it’s better not money out want to grow the business

Sahil (04:16)
yes, I mean, if you want to grow the business and you want to, you’re preparing for an exit, I would say that it’s the C Corp ways is a better option because you’re not going to be taxed when you keep money within the C Corp versus.

Pankaj Raval (04:21)
preparing for an I would say that the C Corp a better option because you’re not gonna be taxed when you keep money within the C Corp. Oh really,

I don’t have to pay any taxes if I keep it in the C Corp.

Sahil (04:33)
you will have to pay taxes, but the way it works is if you, first of all, you’re gonna have some level of corporate profit. The company itself is going to earn a profit after it applies all of its expenses. And then on that money, you have a choice. you want to distribute those, remaining profit as dividends after that initial corporate tax? Or do you wanna retain the earnings in the corporation, in which

Pankaj Raval (04:34)
pay taxes but the way it works is if first of all you’re going to have some level of corporate profit the company itself is going to earn a profit after it applies all of its expenses and then on that you have a do you want to distribute the remaining profit as dividends after that initial corporate or do you want to retain the earnings in the corporate in which

Sahil (04:59)
You aren’t paying tax on that money

Pankaj Raval (04:59)
you aren’t paying tax on that

Sahil (05:01)
because you’re not distributing it.

Pankaj Raval (05:01)
I

don’t have to pay any tax if it is a corporation on the money I keep in?

Sahil (05:07)
You only have to pay on the corporate profit once, then on the money that’s retained as aren’t paying tax on that money. That money you’re able to apply towards your future business and future expenses.

Pankaj Raval (05:11)
the money that’s retained is you aren’t.

business and feature.

so I wouldn’t have to pay it personally. As opposed to like an LLC where I have to pay, if it kept money in then I would pay personally, whatever that distribution would have But with the corporation, you’re saying would just pay like a tax on whatever is retained in the corporation. But then beyond that, there’s no tax owed.

Sahil (05:36)
You’re right, there’s no tax owed as long as that money isn’t distributed as a dividend to the owners. that brings up a great point, which is what’s the difference here? One is a pass-through entity and one is not a pass-through entity. So what’s a pass-through entity? An LLC is a pass-through entity, which means or not you actually physically actually take a cash distribution, the profit at the end of the year is allocated to you, which means the IRS

Pankaj Raval (05:40)
Okay, okay brings me great point, is what’s the difference here? One is a pass-through entity and one is not a pass-through Exactly. So what’s a pass-through entity? An LLC is a pass-through entity, which means whether or not you actually, basically, actually take a cash distribution, the profit at the end of the year is allocated to you, which means the

Sahil (06:03)
is going to tax you on your profit, whether or not you take it.

Pankaj Raval (06:03)
is going to tax you on your profit, whether or not you take it.

Sahil (06:07)
And so, yeah, that does suck. So called phantom income. And that’s why when you don’t the ideal candidate for an LLC is single is going to be taking a distribution for themselves.

Pankaj Raval (06:07)
⁓ that sucks. Okay. That’s not fun. Yeah.

Sahil (06:24)
they aren’t expecting to have a major exit. They’re

Pankaj Raval (06:27)
they’re expecting to pay themselves with cash distributions. You can organize your payments as guaranteed payments in an LLC. But when it comes to the C Corp, you don’t have pass, it’s not a pastor entity. So your corporation is paying taxes, which on its surface looks in a corporation, you’re not planning on distributing the entire amount of money to

Sahil (06:27)
expecting to pay themselves with cash distributions. You can organize your payments as guaranteed payments in an LLC, but when it comes to the C Corp, you don’t have pass through, it’s not a pass through entity. So your corporation is paying taxes, which on its surface looks in a corporation, you’re not planning on distributing the entire amount of money to

Pankaj Raval (06:49)
So for example, let’s take an LLC where your

Sahil (06:49)
So for example, let’s take an LLC where your profit

at the end of the year is about $200,000. might be enough for someone who’s a single member to say, well, I actually need all of that not keeping that money in the LLC now let’s say your company making millions of dollars and you need to make capital investments the following it’s better to go with a C

Pankaj Raval (06:52)
keeping that in the LLC but now let’s say company making millions of dollars and you need to make major capital investments the following it’s better to go with a C

Sahil (07:12)
because you can retain your earnings, you can invest in

Pankaj Raval (07:12)
because you can retain your earnings you can invest

Sahil (07:15)
things that you’re going to need the following year. So that’s a big difference pass-through entity and that’s subject to corporate-level taxation.

Pankaj Raval (07:15)
the things that you’re going to need the following year. That’s a big a pass-through entity entity that’s subject to corporate level

Interesting, interesting. there any downsides for quitting a corporation? Yeah.

Sahil (07:26)
Yeah, there

are some I would say that double taxation is the big the one that keeps people away from a corporation. Otherwise, it’s actually quite flexible. You can create multiple classes of Venture capital funds prefer a C Corp because it’s very flexible. You for whatever kinds of classes of that you want. You can contract for preferred

Pankaj Raval (07:29)
would say that double taxation is the That’s the one that keeps people away from a Otherwise, it’s actually quite flexible. You can create multiple classes of capital funds C-corp because it’s very flexible. contract for whatever kinds of classes of

Sahil (07:48)
It’s also much easier to an equity incentive pool in a can do that as well in an LLC with profits interest, but it is more complicated.

Pankaj Raval (07:53)
What do you What do you mean by equity incentive pool? What does that mean? So let’s say you want to incentivize your employees. You’re able in a C-Corp to separate out a class of that allows for your employees to receive that stock as an award.

Sahil (07:59)
So let’s say you want to incentivize your employees. You’re able in a C-Corp to separate out a class of allows for your employees to either receive that stock as an award

or receive it at a strike price, which is an option. So, it allows you, C-Corps provide a very clean structure for you to offer corporate incentives to your employees where they can participate

Pankaj Raval (08:11)
Or receive it at a strike which is an it allows you to see corpse are provide a very clean structure for you to offer.

Sahil (08:23)
and ride along as the company grows. And usually because a C Corp is kind event, some kind of venture capital event, the employees are incentivized to work hard and align with the company’s they get to participate in that So I would say usually if you’re running a cashflow business, say you’ve got a small business, you’re operating a chain of dry cleaners, a chain of restaurants, you’re operating,

Pankaj Raval (08:33)
Yeah with the company’s they get to participate in would say usually if you’re running a cash flow business

Let’s say you’ve got a small business, you’re operating a chain of dry cleaners, a chain of restaurants, you’re operating

Sahil (08:48)
something where cashflow, regular cashflow is involved and you’re not expecting a major financing a great candidate for an you’re still able to offer incentives, just a little more with a C Corp, that’s a great option for something like what you’re doing, which is running

Pankaj Raval (08:49)
something where cash flow, regular cash flow is involved and you’re not expecting a major financing that’s a great candidate for an And you’re still able to offer it’s just a little more with a C-Corp, that’s a great option for something like what you’re doing, which you’re running

Sahil (09:05)
you’re going to provide services to a medical corporation. You’re going to have a very large staff. You’re going to

Pankaj Raval (09:06)
You’re going to provide services to a medical corporation. You’re going to have a very large staff. You’re going to

Sahil (09:12)
employment agreements, eventually intending for some kind of capital or financing event. That’s

Pankaj Raval (09:12)
complicated employment you’re eventually intending for some kind of venture capital or financing That’s where…

That’s where corporations are very attractive and you’re going to incentivize different investors in different ways with different rates of You want that level of flexibility in a

Sahil (09:20)
where corporations are very attractive and you’re gonna different investors in different ways with different rates of want that level of flexibility in a

Pankaj Raval (09:30)
interesting. So it sounds like, in my situation, a C-corp makes more sense. Yeah, okay. That’s interesting.

Sahil (09:35)
Well, let me ask you, are you

raising money from family and friends right now? Are you raising money from venture capital funds, from private equity? Are you taking on debt? What’s kind of your financing stack here?

Pankaj Raval (09:38)
right now or are you raising money a

taking on debt. What’s kind of your financing

So, I mean, we need money quickly to keep the operation going. So we have an investor who’s going to be investing a little bit of money right now in the company. But then, yeah, we’re trying to raise, get outside investors in the next probably six months too. trying to go out and try to raise quite a bit more money because, to expand and to get other locations for this, we need to raising more money

Sahil (10:04)
Exactly. And so if you do need to raise money and you need to incentivize and offer different types of rates of return or different kinds of voting rights versus economic rights, different kinds of distribution rights, if different people are participating at different levels and there needs to be a waterfall C-Corp is definitely better. Now,

Pankaj Raval (10:06)
You need to raise money.

Okay.

Sahil (10:21)
how many owners do you expect and how actively involved do you see those owners being?

Pankaj Raval (10:26)
So I see many, I mean in terms of owners, probably two or three people managing the day-to-day operations. I will be coming in as the physician, helping, actually doing treatments, but I think, we have two or three people who have experience in this industry. We’re gonna be managing the day-to-day.

Sahil (10:40)
Yeah, in that case, you want the governance controls that a C Corp offers as well. In a C Corp, you’re going to have a president, a secretary, a treasurer. You’re going to have a board of directors. You want to governance rights in a way because otherwise, who pays for what and who gets paid and who’s making any kind of decision, especially in an organization like that where there are complex decisions. There might even be a separation

Pankaj Raval (10:41)
you want the governance controls that a C Corp offers In a C Corp you’re going to have a president,

want to the governance rights in a organized way because who pays for what and who gets paid and who’s making any kind of decision, especially in an organization like that where there are

Sahil (11:06)
medical decisions versus administrative decisions, business decisions, you wanna be clear on who’s making what And so, especially because there are, when it comes to medical organizations, there are HIPAA compliance concerns as well. So you wanna make sure you’re taking into making because needs to be a very clear chain of responsibility for liability purposes for insurance companies.

Pankaj Raval (11:17)
of their HIPAA compliance concerns as well. So you want to make sure you’re taking into making decision needs to be a very clear chain of

for liability purposes for insurance

Sahil (11:30)
companies, to see very clear of and very clean communication and approvals with regard to agreements, with regard to financing, with regard to insurance, with regard to any kind of corporate decision that’s being

Pankaj Raval (11:30)
Insurance companies, want to see very courses of very communication and approvals with regard to agreements, with regard to financing, with regard to insurance, with regard to any kind of corporate decision that’s That’s a good point. What else do you need to know to figure out how we can structure this? Well, there’s

Sahil (11:47)
Well, there’s one more

element here that’s beneficial if you go to C is qualified small business stock. And so this allows you to exclude if it’s structured properly up to 100 % of capital gains on your sale.

Pankaj Raval (12:04)
business can take advantage of this

Sahil (12:06)
So

it’s not any business. have to hold the stock for at least five years and the business must be an active operating business. So that means that at least 80 % of the assets that are held by the business, meaning it can’t be a holding company. So 80 % of the assets must be used in the active business.

Pankaj Raval (12:11)
and the business must be an operating So that means that at least 80 % of the assets that are held by the business, meaning it can’t be a holding company. So 80 % of the assets must be used in the active

Sahil (12:25)
I also want to tell you about another advantage with a C Corp, is that you may be eligible for QSBS, the Qualified Small Business Stock Exemption. And this allows you to take up to 100 % of your capital upon sale. requirements are you have to hold onto the stock for more than five years. The stock has to be issued by a domestic C corporation and it has to be a qualified trader business.

Pankaj Raval (12:27)
C Corp. is that you may be eligible for a QSB as the qualified small business stock exemption. And this allows you to take up to 100 % of your capital sale. requirements are you have to hold onto the stock for more than five years. Stock has to be issued by domestic C corporation. And it has to be a qualified trader

the IRS

Sahil (12:51)
the IRS had

enumerated a number of businesses that don’t for example, professional services, banking insurance, hospitality, farming. So the question in this case, might require a little bit more research, but there is a world where a management services organization qualifies because it’s not the one doing the medical work.

Pankaj Raval (12:52)
enumerated a number of businesses that don’t So for example, professional services, banking, insurance, hospitality, farming. the question in this case, it might require a little bit more research, but there is a world where an management service organization qualifies because it’s not the one doing the

Interesting. That’s interesting. Yeah, that sounds actually very attractive. We’ll have to chat more about that and see if this is something that could qualify. This is great. Thank you, Sahil. This is really interesting analysis. I had no idea about some of these nuances and corporations. So thank you.

Sahil (13:27)
Well, I love it. got to come to Carbon Law Group. We’ve got the answers. It’s what we do all day. Yeah.

Pankaj Raval (13:28)
know, you got to come to Carp and Log Group. You got the answer. You do. You do. You guys seem great. You guys

seem great. Like you guys really know what you’re talking about. look forward to to working together.

Sahil (13:38)
Yeah, exactly. Me too.

Pankaj Raval (13:40)
all right, well, you will be the end of our role play today. If you guys want more, we’ll give you our OnlyFans link in the show notes where you’re gonna see a little more racy content from us. You could be our first subscriber. was just joking. But yeah, hope, at all serious, We hope you guys found this helpful. I think it was a lot of really valuable information

Sahil (13:49)
You

That’s right, we might even get into S-Corps. Yeah, exactly. That’s right.

Pankaj Raval (14:06)
consider when you’re starting a is a big question between when to start an LLC versus when to start an not like a straightforward issue where just answer one question and find the answer. There’s probably a variety of considerations to make as we discussed today. This is just kind of the tip of the iceberg as well. It really depends on the business you’re starting, why, what your goals are. And we’re here to guide you along that way. We structure many, many businesses. Every week people come to us with these questions. So we’ve

years and years of experience doing it and can guide you along the right based on what your goals are so you guys are confident you’re making the right decisions going forward. And that’s a big difference between starting a business on your own versus working with a professional. an investment, but the question is, do you want to make that investment in your future or not? We do believe that we do provide a strong ROI on that investment and to be getting compound interest in this business as you grow it.

Thank you Sahil for walking us through the complexities of starting an LLC versus a corporation and the differences. One type of business entity we didn’t talk about, and there’s several types of entities we could consider, but the other one is an S-Corp and there’s some kind of a hybrid between an LLC and C-Corp, isn’t eligible for QSBS. So if you’re looking for that QSBS benefit, you’re not gonna get that with an S-Corp.

Sahil (15:14)
Pankaj you just brought up is the client that when they come to you, you say,

Pankaj Raval (15:16)
why do you like is the client that when they come to you, say,

Sahil (15:20)
You need an

Pankaj Raval (15:20)
you need an

Sahil (15:21)
is that ideal client? Who’s eligible for an

Pankaj Raval (15:24)
Yeah, so Sahil, a great question. Oftentimes it’s a professional service provider in many ways of starting an S Corp. That’s probably the easiest answer to that. However, smaller companies, too, they’re not looking to raise money outside capital and also trying to limit their tax exposure because there are real benefits to starting an S Corp for tax purposes, especially when compared to an LLC, with an S Corp, paying potentially self-employment other FICA taxes.

Because LLC, everyone needs to remember that you are not only getting taxed on your income, whatever you make from that LLC, but you’re also going to be paying a 15.2 % in self-employment taxes. So the main difference is that, you know, with a S corp, you can actually make yourself an employee on the, the company. You pay all the normal employment taxes that you would pay any other employee that you hired. But then the benefit is that any other distributions beyond that are not, you don’t have to pay the self-employment tax on that.

There are some nuances overall, you can really save as you make more money with S-Corp. It really makes sense when you start making 150, 200,000. It doesn’t really come into play until you kind hit that threshold. But once you start making more than that, you can really experience some savings versus an LLC. So that’s why said professional services for sure, that’s what’s one party that always should be really thinking about an S-Corp or an S-Election. One thing people don’t realize too is that actually with an

can make an S selection. can check the box to say, hey, even though I’m an LLC, I don’t want to be taxed as a partnership. I want to be taxed as a S corporation. And you can actually do that. Those are things we can walk you through and help you with. So a lot of these things people don’t realize, a lot of ways to kind of look at the taxes, look at how much income you’re making and make some projections and actually structure your NED accordingly. whenever you’re discussing NED structure, you should be having a conversation about legal structure, but also about financial and tax structure.

it’s gonna make a big in how you grow.

Sahil (17:10)
So why would somebody pick an LLC tax as an S-Corp versus just an LLC tax as a

Pankaj Raval (17:17)
great question.

in LLC taxes and S corp, really you get the benefits of both. You get the simple structure of an LLC, operating agreement, know, fewer organizational docs, but there’s the benefit of being taxed as an S corp and you get the advantages of paying potentially lower taxes. That’s kind of why we do it. However, I will say that it can get complicated as you grow,

want to issue equity stakeholders, to employees, it’s not as easy even with an LLC taxes and S corp, because they’re kind of hybrid structures. There’s not a lot of clear guidance because they’re not used as much as to how certain grants will be will be taxed, will be treated. Sometimes even some of the legal documents can get a little bit complicated because, are you an S corp or are you an LLC? It and

it can get a little complicated. So if you want to be smaller, if you want to make this kind of a smaller entity, you’re not really planning on growing too much, but you just want to make using this to sell kind of do drop shipping or Tiktok whatever it might be, that probably is okay. But if you want to grow, if there’s gonna be more people involved, if you want to start giving out equity, raising money, I don’t recommend any of these kind of more, exotic structures, because even though they do really your corporation or corporations probably the best is if you want to grow and

and raise funds. If you want to be an LLC, mean, LLCs are oftentimes best for like real estate. Those are really built for real estate and holding hard assets. I wouldn’t recommend an S Corp or a corporation necessarily for a real estate business, but they’re really often used in the real estate context, which makes the most sense. But again, if you’re trying to grow it, if you’re trying to raise more funds, then you may want to have a corporation as a parent company than LLCs below it. So we can talk about those structures and

determine what the right structure is for them.

Sahil (18:50)
Perfect.

Pankaj Raval (18:51)
right. Well, thank you, Sahil. This is great. I hope everyone found this conversation really helpful. have questions about structuring your business or want to find out more, please reach out. This again is Carbon Law Group and you’re listening to Letters of Intent. Until next time, please like, follow, share for more.