We started to work on our OtoCo product with 2 goals in mind: 1. We wanted to compress the time and cost of forming a new legal entity; 2. whilst maintaining legal validity.
The demand for a "company at the push of a button" is heard quite often in entrepreneurial circles. Here are some recent calls:
We believe there are two main reasons:
Companies formation is still largely done by lawyers and accountants. Their rituals go back to a time when companies were set up for a privileged class in society.
Resistance by middlemen combined with a reluctance to move away from the way things have always been done often conspire against the adoption of new technologies. It is not so long ago that we booked our flights through a travel agent, whilst now we all buy tickets online and send our boarding passes to our phone.
Company formation will inevitably go the same way
2. Legal validity
Secondly, new technology brings old fears. Will a company formed entirely online, without legal intermediaries, still be legally valid? If it can be done so cheap can it be good?
These fears may be justified and deserve a closer look.
The source of all legal validity is self-evidently the law. In the realm of company formation, Governments have by law monopolised the issuance of new incorporation certificates - legal "birth certicates" for companies - to official Registries.
Some of these Registries may be privately run however typically they are part of Government. In the United States, each State has its Registry.
It is by filing with such Registry that a new company is validly constituted: the new entity will have gained separate legal status from its founders and - if so chosen - limited liability.
Typically, not just everybody can file: in some countries, only licensed entities can do so. In other jurisdictions, most notably the UK, anybody who wishes to form a new company can file directy with the Government Registry, in paper form or online.
In summary, there's due process in forming a new legal entity. Legal validity doesn't come from lawyer involvement - though lawyers like us to believe it does - but from respecting due proces.
As long as new technology follows due process, it can disintermediate away the analog and anachronistic rituals administered by the legal profession.
The result will be a process that can be condensed in both speed and cost. Before we examine how, we need to have a summary understanding of how US LLCs are created.
Limited Liability Companies are widely used in the US as "pass through" vehicles for tax reasons: its revenue is taxed - or passed through - at the level of its Members and not at the Corporate level itself.
At the extremes, they're being used as single purpose vehicles, e.g. to hold a property or a trademark, or as the operating entity for large enterprises, and any purpose inbetween.
In Delaware, home of most US LLCs, a simple Certificate of Formation is filed with the Delaware State Registry with mention of the chosen name and the name of the first Member(s).
If the desired name is not taken, a new LLC will typically be formed on the same day or within a day of filing, without any verification whatsoever of the identity of the first Member.
This lack of attestation of identity at the moment of formation of a US LLC helps enourmously in condensing the process: most jurisdictions require upfront Know-Your-Customer and Anti-Money Laundering checks when forming a new company, either at the official Registry level or by licensed formation agents, making the whole process a stop-start event which is difficult to automate and optimise for speed.
By contrast, in the US such checks are effectively pushed out and performed later in time when the need arises, e.g. when the LLC applies for a bank account. As with real birth, the company's birth certificate gets issued first, the passport follows later - and only if there's a need to travel!
Still, for every new LLC filed, there's a wait until Registry stamps its birth certificate. To bring our speed down to seconds, rather than hours, we had a closer look at a relatively new variant of the LLC, the Series LLCs.
A Series has a Master and individual Series. Each Series is considered an LLCs in its own right, with its own name and its own Member(s) independent from the Members of the Master LLC and other Series' Members.
Crucially, the assets and liabilities between the Series amongst themselves and between the individual Series and the Master are entirely firewalled (though there is not yet sufficient caselaw to confirm this firewall is 100% secure in all States).
It is the Master that spawns the individual Series without the need for extra filing with Delaware State Registry: its first Member simply signs an Operating Agreement and all that is required from the Master is to keep a record of each individual Series' chosen name and initial Member.
In this legal construct, the time to spin up a new entity can be further reduced. However, there's still a signature required, which introduces latency.
To make this at the push of a button, as was our goal, we had to go a step further.
Individual Series need a first Member. In the analog world, this Member would either be a physical person or an official of a company who would sign an Operating Agreement and send it to the Master LLC.
Even when digital signing is used, the Master still needs to create a record of the name and Member of the Series for it to be validly activated.
Our key discovery in this respect was that the first Member of a Series LLC can be a smart contract address.
As a result, a Series could be spawned by activating a smart contract that held the Series Operating agreement and sign it by making a cryptographic transaction on blockchain.
In this setup, the first member of the series LLC is he or she who controls the wallet that sends the Ether to the Master LLC smart contract address that spins-up the Series LLC Operating Agreement smart contract.
Proof of existence of the new LLC is the smart contract created to hold the Series LLC Operating Agreement. Proof of ownership comes from the public key that shows the address of the first Member who sent the transaction to the Master smart contract.
To make it easier for users to interact with the destination address of the Master LLC, we linked its public address to
otocorp.eth , a more human-readable name, using the Ethereum Name Services.
We put the cost of activating a new LLC at 5 DAI which if we get to 60 Series LLCs will help OtoCo LLC as the Master pay the USD 300 Annual Franchise tax in Delaware.
In addition to the 5 DAI, users will need to have a very small amount of Ether in their wallet to cover the gas costs of the 2 transactions, a first one to make the payment of 5 DAI and a second to activate the new LLC. All this is completed within 5 seconds on average.
With the filing itself now fully automated, the only other speed bump left was the name.
When forming a new LLC, including a Series LLC, any name can be chosen (with some exceptions) provided it is not already taken. For instance, try filing
Goldman Sachs LLC and the name will be rejected after a name check by the Registry.
In the context of a Series LLC, there is no Certificate of Formation filed with Delaware hence no way for the Registy to perform a namecheck.
Whilst trademark law provides a natural defense against anybody duplicating a registered name and risk legal action as a result, it would hence still be possible to register
Goldman Sachs LLC as a Series LLC.
The way some other U.S. States that have Series LLCs deal with this is by imposing naming restrictions. For instance, in Wyoming
Goldman Sachs LLC could not be used as a standalone name and would have to be referred to as
Goldman Sachs LLC, a Series of OtoCo LLC .
However, we could not find any such restrictions in Delaware, even though the above naming is typically adopted as a convention.
Also,we did not want our users to have to adopt this naming convention and refer to their Series LLC as a "Series of OtoCo LLC".
The solution was to use an API to perform a live namecheck as a first step in the online order process.
Whilst Delaware is one of the many States in the US that does not have an API into its State Registry, there are third-party databases such as Open Corporates which provide a reasonable degree of accuracy.
Thanks to this live namcheck, users can instantly spin up their LLC with the name of their choice. This prevents naming conflicts and possible lawsuits as a result.
Finally, we wanted to share the results of our "blockchain litmus test" by asking if the same result could be achieved without the use of smart contracts.
The naming API obviously does not require blockchains: Until blockchains are used as authenticated ledgers for company names (in the same way ens.domains is an authenticated legder for .eth domain names) our solution is entirely database-based (despite the absence of an official public database!).
The spawning of a new Series by the Master could also be done without blockchain: a Stripe payment could be made to OtoCo, with an API that feeds into an online document generator which could be emailed to user for digital signature via a DocuSign-type solution. Once signed, OtoCo LLC as ther Master would be notified and the Series would be validly formed.
However there are a number of reasons why we believe blockchains are superior to a more centralized, approach:
PRIVACY: Any card payment method would be surveilled: the payer would be know and assuming payer is also first Member, the company would not be private up to the point the Member choses to attest to his/her identity.
LATENCY: Speed-wise, stringing together a card payment module with an API with document creation software that requires a digital signature is very different from a solution in which a company is automatically spawned by simply inseminating a smart contract.
CENSORLESS: Any centralised approach would not be censorless, in a sense that anybody can now own a company and be an entrepreneur.
AUTHENTICATION: A payment by Stripe to trigger the Series LLC creation has no equivalence to proof of ownership of a digital wallet, which makes the activation payment and ownership of the company coincide.
FUTURE-PROOF: An on-chain company is future-proof. Further functionality that uses blockchain both as a ledger and rails for transfer of ownership of "smart-contractified" company equity will change forever how we fund and govern legal entities.