“You’d better to set up your company abroad. What is more, think twice before incorporating your business in any offshore zone, and choose the safe jurisdiction closer to Europe or the USA”. This piece of advice sounds as good as your grandma’s request to wear a hat, or treat yourself to a warm apple pie before you go to sleep.
We are all free people here, and we have the right to be engaged in any kind of business activities that are not prohibited by law. Are we allowed to trade Bitcoins on the Chinese Bitcoin Exchange? Yes, we are, since Bitcoin is not prohibited in Ukraine. In addition, nobody can ban you from setting up a startup. Without any registration. Business operations without registration are restricted by law. But in Ukraine (and this is the real trouble), a startup doesn’t necessarily mean entrepreneurship.
So, here’s the tip No 1: Take it easy. Although owning a sole proprietorship is hardly enough to guarantee your success, but it can be quite handy if you want to check how the whole thing works. Let us group the companies by certain types, depending on what you need:
- Companies for doing business here and now;
- Companies for attracting investors and fine tuning the corporate management.
The Ukrainian Offshore
The truth is, the Ukrainian lawmakers haven’t invented anything better that a sole proprietorship and a simplified tax system. No kidding, if you want to set up a startup, that’s just the thing.
A sole proprietorship is not a company. It’s an additional status, and at the same time, it is an extremely convenient form of business with the simplified financial accounting and reporting, and a minimum tax rate.
To start receiving payments from prospective customers, it’s enough for you to have only three documents: an agreement with your customer, an invoice, and a delivery and acceptance certificate for the services rendered. If you are an entrepreneur acting as a sole proprietorship, you are free to choose the simplified tax system (the 3rd group) and pay 5% turnover tax.
Truth be told, there are certain disadvantages. To start with, if you pay 5% tax, your annual turnover cannot exceed 5 million UAH (Currently, a little less than 200 000 USD). Unlimited liability is another disadvantage: the owner of a sole proprietorship is personally and fully liable for any business-related obligations. So, incorporating the Ukrainian LLC is another option.
What is so special about the Ukrainian LLC? The liability of the founders of a limited liability company in Ukraine is limited to their equity payments. This is just for the record. The main advantage of the Ukrainian LLC is that its founders are entitled to divide their shares in any project, and not only in a virtual project, but also in your corporate bylaws. All the assets of your project will belong to the LLC. I guess you’ve read this sentence very quickly, and haven’t paid much attention to it. That’s why I’m going to put it another way: if you own the LLC, you can transfer all assets to this LLC, and by doing this, you will minimize the risks of disputes. However, things happen, and you’ve definitely heard about such disputes as “the founder has left the project and took the domain name” or “our company’s PayPal account is linked to the founder who’s been fired, and he refuses to give back the money left on the account”.
Financial accounting in the LLC is more complicated than that in the sole proprietorship. However, it is not complicated to the extent that you’d have to hire one of the Big 4 companies to deal with it. The simplified tax system is also an option for the LLC in Ukraine.
How Funding Works
You shouldn’t whistle inside the house. The same goes for investing into the Ukrainian LLC. If an investor wants to invest some money into the Ukrainian LLC, then this investor is either extremely smart, or impossibly stupid (as the case may be).
Here’s what investors don’t like (especially those who aren’t the Ukrainian citizens):
- The Ukrainian assets, including corporate rights, are always risky. Of course, the right to private ownership is guaranteed in Ukraine. However, it is not always clear who’s actually going to guarantee it, and how.
- The LLC in Ukraine is cut off from the European and American civilizations. The foreign currency exchange control, agreements with wet stamps, as well as the delivery and acceptance certificates executed in two original copies, are the sacred instruments for the Ukrainian tax authorities, while your clients from Europe and the USA would look at them as though they were some ancient artifacts;
- The number of corporate management instruments in the Ukrainian LLC differs from that in the US C cop as much as the desk dial phone differs from iPhone 5.
But wait, there’s more about the advantages of foreign companies. When it comes to the venture investment, we as a rule apply common law. However, you cannot apply common law to the Ukrainian LLC.
The Shareholders Agreement is the main incorporation instrument of a company. It determines the broad range of the rights of the founders, investors and other shareholders, and includes provisions about a company’s management system, stock turnover and resolution of disputes between the founders, etc.
Here you will be able to offer stock options to your employees, and thereby, motivate them to turn some MVP into a full-value product, or turn your company that started in a garage, into the next global brand like Facebook, Uber, or Instagram.
A Convertible Note, a form of convertible debt, is another popular form of fundraising: the investor can buy the corporate shares at a reduced price during the next round of investment. While such mechanisms are widely used in the western world, they are absolutely inapplicable in Ukraine.
It sounds nearly perfect and simple. However, according to the National Bank of Ukraine regulations, if you incorporate a foreign company, or make equity investments, or set up a bank account abroad, this means you’re investing abroad, and you have to obtain an individual license for such operations. The funny thing is, it is nearly impossible to obtain such license, so most companies operate at their own risk. There are heavy fines for infringers, which are equal to the amount invested. However, as luck would have it, there is a compensation for heavy penalties, i.e. there is no mechanism for the investigation and application of the penalty itself.
Well, of course, since I am bound by the oath of a lawyer, I’m not in the positions to advise you to violate the law. But on the other hand, I am a strong supporter of startup development in Ukraine. In my opinion, the ban on investing abroad is a total nonsense, and I’m sure that it will end up just like monuments to the communist leader Vladimir Lenin throughout Ukraine.
Which jurisdiction is the best to incorporate a company? This question has as many answers as “Which programming language is the best?”. We fancy the USA and the UK.
If you are going to incorporate a company in the USA, then the C Corporation is the most reasonable choice. The C Corporation is a privately held corporation (it’s similar to a private joint stock company in Ukraine). All companies in the USA are subject to the federal income tax (35% notwithstanding the country of origin) and the state tax, which in some cases may be zero tax. In addition, it’s always a good thing to stay close to the Valley.
The limited liability partnership (the LLP) is the most popular form of a business organization in the UK for non-UK residents. If the LLP operates outside of the British market, it is exempt from the income tax. This type of company may be de-facto considered the European offshore company.
Although investing into the US or the UK companies is attractive to investors, this doesn’t necessarily mean that setting up a company in these jurisdictions is financially beneficial for startuppers. If you want to save money, then you should set up a company on an island where there are no taxes and financial accounting. Investors are wary of such companies, but still give them money.
Business incorporation is not a linear process like “a sole proprietorship – the LLC in Ukraine – an offshore company – a Delaware corporation”. It doesn’t work that way. A Delaware corporation and a dozen of sole proprietorships in Ukraine may be just the thing for you, while a dozen of the LLCs in Ukraine, the UK corporation, plus the BVI trust will work perfectly well for others. By the way, one of our clients who’s in business for almost 10 years (a hardware startup working for foreign customers) sought for legal advice for the first time and told that using the sole proprietorship wasn’t convenient for him anymore.
“And what about the joint venture agreement?”, our sophisticated readers would wonder. And here’s my answer: “Anything but that!”