In my experience working with 15+ startups in Upekkha cohorts and a few others as an early investor and advisor, I have frequently come across the dilemmas faced by founders when it comes to choosing a legal entity. Founders are often confused between the options of structuring their business and understanding their considerations – be it an Indian Entity, a US Entity, a US Entity with India subsidiary or an India Entity with US subsidiary.
The aim of this write-up is to discuss all these options in the current scenario.
The Determining Factors
The first step in determining this is to answer the following questions:
- Do you want to be a global business?
- Do you want to be branded as a global company?
- Do you have or plan to have customers outside India?
- Do you have customers, for whom the billing has to be done from USA?
- Do your customers need support from USA ?
- Do you need any customer-facing functions (sales/marketing/support) to be present in the USA?
- Do you plan to raise investments in the USA or from foreign investors?
- Do you plan for a M&A in the future?
- Do you plan to have your founders or employees move to the USA on business?
If the answer to one or more of these questions is “Yes”, then you should strongly consider having a US entity. This should be incorporated preferably from Day One of your startup to make running your business simpler. This includes:
- Optimising how you set up your customer-facing teams
- Setting up multi-currency payment gateways for invoicing and payment collection
- Working with US and other global investors
- Compliance requirement on inducting foreign investors
- Building partnerships for business growth, and
- Building strategic partners for potential merger and acquisition
Even though, I am personally not in the favour of asking my Indian citizen friends to move their business out of the country, the ease of operating a business in USA and the challenges of business compliances in India makes this a compelling option. Additionally, the advantages of having a presence in the USA have made many startups in India to operate as a legal USA entity.
A founder/CEO’s responsibility to its shareholders requires the startup to take such decisions keeping the overall interest of the business. The founders of such startups continue to contribute to the technological strength and the economic upside of India with the entire team working out of India.
For businesses that are planning to raise investments from US or investors outside India, this decision should be a no brainer. This includes alternate investments such as Revenue Based Financing more prevalent in the USA (such as lighter capital and SaaS capital), and for those who are considering a Strategic Partnership or Merger/Acquisition, or need access to public market capital (through an IPO).
The process of due diligence, compliance for moving money into and outside India, tax implications and the end-to-end transaction processes are much more laborious and time-consuming when you don’t have a US entity. Having a US entity will come handy if you need to have your employees or founders move to the USA on H1 or L1 visa as the US entity can file for your Visas.
So, if you foresee the possibility of having a US entity, I recommend that you do it right away. This is to avoid the hassle of having to flip the entity structuring later when the process is more expensive (due to the value created in the Indian entity) and time-consuming (multiple steps to transition existing business and reduce costs).
Questions that are often a dilemma
Can I operate with only a US entity and not have any Indian entity at all?
Some startups operate as a US entity without any Indian entity, while the founders are based in India. This is not the right thing to do since having an Indian entity along with a US entity will ensure you are compliant with the Company laws in India. You should check out the POEM guidelines which defines “Place of Effective Management” and test for tax residency even if you are operating from a US legal entity only. It is recommended to take legal and CA advice on this.
Should the US entity be a subsidiary of India or Should the India entity be a subsidiary of USA?
Once you decide to have a US entity, then the question you need to answer is whether to structure the US entity as the parent company (with the Indian entity as a wholly owned subsidiary) or make the USA entity as subsidiary of the Indian entity.
If you are starting your business (i.e. at very early stages of your business), then I would recommend you go with the better-understood model of making the US entity the parent company and having the India entity as a wholly owned subsidiary of the Indian entity.
You should consider setting up the USA entity as a subsidiary of the Indian entity only if:
- You want to have the flexibility to keep the Intellectual Property outside of the USA
- You are considering to do this structuring at a much later stage of your startup growth
- The cost for making your Indian entity a wholly owned subsidiary in the USA is high and impractical because you are already too late in the process
Both are possible. To illustrate:
- Kissflow set up in this less common model through a distribution services agreement with the US entity which acts as a subsidiary of the parent company in India.Read this post for more details:https://www.chargebee.com/blog/how-to-incorporate-in-the-us-v2/
- Freshdesk (now Freshworks set up in the more common model of having a US parent and the India entity as a wholly owned subsidiary. Read this post for more details: https://freshdesk.com/general/how-to-incorporate-a-us-corporation-from-outs-blog/
Should the entity in the USA be a C-Corp or LLC?
I would recommend that you incorporate your US entity in Delaware. Delaware is the most favoured corporate domicile in the USA. Delaware Corporate law is most company-friendly providing maximum flexibility, and minimum red tape, confusion and procedural expenses. It is also well-tested and proven with most corporate attorneys familiar with Delaware Business Laws.
Here are the primary considerations which will help you choose the business entity:
- How to protect your personal assets from liabilities of the business
- Tax strategies such as maximising the tax benefits of startup losses
- Avoiding double layers of taxation, and converting ordinary income into long term capital gain which is taxed at lower rates
- Selecting an entity that will be attractive to potential investors and lenders
- Availability of attractive equity incentives for employees and other service providers
- Cost (startup and ongoing)
Consider setting up a C-Corp, if:
- You want your business to be a separate tax-paying entity
- You want to raise funds from external investors
- You want to grant equity to employees, advisors or investors
- You want a regulated governance structure
If not, you could consider setting up an LLC which could be transitioned into a C-Corp whenever required. When it comes to taxes, the difference lies in who is registered as the taxpayer. It is to be noted that an individual/founder is registered as the taxpayer and the profits earned are included in the personal taxes. A C-corporation, on the other hand, is registered as a separate tax-paying entity and its profits and losses are accounted for by the corporation, not the founders.
In other words, C Corp is taxed differently than an LLC. This becomes very important when you intend to pay yourself or other founders in the US. For an LLC, you will only be taxed once mostly at individual level, but for C Corp, your company will be taxed as well as the individual receiving the dividends. Make sure to talk to your CA about this.
After clearing the Why & What, now the how
How should I set up a US entity?
The best way for startups in India to setup an entity in the USA is to use Stripe Atlas. Stripe Atlas helps entrepreneurs start an internet business by forming a C-Corp or LLC in Delaware, issues stock to founders of a C-Corp, obtain US Employee Identification Number for tax purposes and open a US business bank account all remotely. There is a one-time fee of $500. https://stripe.com/atlas
There is a small chance that your startup may not be approved by Stripe Atlas. If it happens, it is mainly due to the nature of your business. As long as the businesses are not a Stripe Restricted business you should not have a problem https://stripe.com/us/restricted-businesses
In case you are unable to setup through Stripe, you have other options, however with multiple steps to be done separately.
A few options to consider are:
While the basic service and fee are for incorporation, you will have to avail other services such as procuring the EIN (Employer Identification Number), appointing a registered agent and optional services such as mail forwarding.
While Stripe Atlas provides you with a business bank account (they are tied up with Silicon Valley Bank and Azio Bank, to provide all approved applicants with a business bank account for C-Corp and LLC respectively), the other options listed above require you to set up the bank account independently.
You should hire a legal counsel in the USA who has experience working with Indian startups and have them help you with things outside of the scope (provided by the above sites), especially the tasks that need to be done once the company is incorporated and you have an EIN and a bank account. This task is mainly to subscribe shares for founders, have founder agreement and employment agreements in place and to bring in any existing or new investors as shareholders into the company. Similarly, you will need to engage a CPA (similar to a CA in India) to help with your Delaware filings and your annual taxes.
If you are concerned about the cost of doing all these, many of the startups in our cohorts have done this in a cost-effective way (less than $1000 to incorporate, get EIN, get forwarding address, set up bank account with initial share capital, sub $2000 per year for book keeping and all Delaware and corporate tax filings)
IMPORTANT – What not to do?
After incorporating the USA entity, when you are ready to put money into the bank account for the initial share capital for founder shares, this money should not be remitted from India. Recent regulations on LRS (Liberalised Remittance Scheme) and ODI (overseas direct investment) have some grey areas related to “Round Tripping of money” on whether the money from Indian Residents can be remitted and used for share capital.
I would recommend that the money used for share capital comes in from a person or bank account outside India. In the same manner, if the initial capital is invested by someone other than you, the shares subscribed to this person will then have to be sold or transferred to you. It is still a debate on whether the shares must be gifted to the Indian resident founders or if the Indian resident founders must invest through ODI and purchase the shares at a nominal price. You should 100% take advice from legal counsel in India who understands the ever-changing nuances of this subject and ensure that you are fully compliant with RBI regulations.
After setting up the entity, you cannot ignore the compliance requirement in the USA or India. You will need to engage both a CPA in the USA and a CA in India to ensure all corporate and tax filings are done as per applicable laws in the USA and similarly in India. It is to be noted that once you have an entity in the USA, you have to abide by the laws of USA in spite of you and your co-founders being Indian residents. As per Delaware state law, you will need to maintain a Delaware registered agent and file annual reports with the state of Delaware. Operating as a US entity does not mean you can pay taxes in the USA and avoid taxes in India. You will need to consult your CA to understand the tax laws of India and abide by that too.
In addition, when you form a US entity, you create a legal person in the US, that means that activities abroad will come under US regulations. This wouldn’t be applicable if no US person was involved. The Foreign Corrupt Practices Act and US Export Regulations become applicable to your entity and you as founders. Care should be taken not to violate these US regulations and to be fully aware of these when you operate your business and/or sell your products outside the USA.
For example, bribing a local official (anywhere) violates the Foreign Corrupt Practices Act and operating your business with a country such as Iran violates export regulations and could land you in big trouble.
Based on the entity structuring, both parties will enter into a business agreement detailing the commercials. If the India entity is a subsidiary, then a services agreement on a transfer pricing model is most common.
Irrespective of how you structure your company, you should file your patents in the USA in addition to wherever you are planning to. In general, Intellectual Property, Trademarks and Copyright Protection rules are much stronger in the USA and Patent or Trademark in the USA will be of value when you are considering raising investments or in case of a Merger/Acquisition.
The points made here should be considered as guidelines to increase awareness on this subject. Always consult with your lawyer and CA for legal and financial advice before finalising and implementing any of these. Laws and regulations are subject to change and mistakes made can prove to be quite expensive.
As a founder, your fiduciary duty is to increase shareholder value. A successful founder is able to reduce risk and work towards improving outcomes. Hope these guidelines and recommendations will help you evaluate your decisions and improve your outcomes.