Published by Benjamin S. Thompson - January 28, 2014 - Business & Corporate

While a tech startup company may be impressed with the relative ease of tax accounting for LLCs versus C-Corps, this administrative informality may not sufficiently cover the most immediate need of the startup company: Seed funding and subsequent stages of venture capital raises.

Venture capital firms are composed of dozens of individuals and corporations who band together as Limited Partnerships for the sole purpose of buying startup company stock and then later selling the stock at a profit during the “exit” stage (e.g., Initial Public Offering, or merger/buyout by a larger corporation). These venture capital firms do not want to partner with the startup company, albeit most provide helpful guidance as board members and advisers. Venture capital firms are, above all, shareholders and investors.

Unlike C-Corps, LLCs do not issue shares of stock to their owners/investors. They issue what is sometimes called “membership interest” (or percentage interest) to the owning partners who are designated as such by the LLC’s operating agreement.

It is possible, with some very expensive legal wizardry, to rewrite an LLC operating agreement and make membership interest function similar to corporate stock. But why go through the expense?

At the end of the day C-Corp startups can provide the following attractive points for venture capital investors:

  1. C-Corp startups can issue shares of stock to various entities that may form the venture capital group.
  2. C-Corp startups can issue different classes of stock (this is attractive to investors because each separate round of investment will typically consist of a different class of stock with separate rights from the previous classes of investors).
  3. Voting all of the above various classes of stock when it comes time to make major corporate decisions (e.g., next investment round, or IPO, or buyout) is relatively easy for C-Corp startups compared to the nightmare of working with dozens of “classes” of membership interest in an LLC that was rewritten to function like a C-Corp.

Moreover, the tax benefits of an LLC (or even an S-Corp) are not all that relevant to tech startups because they are unlikely to make any taxable profits in the first 18 months to 2 years of existence. Startups’ stock value may rise when successful, and will increase the number of startup employees and perhaps their salaries, but at the end of the year all of the money earned (if any) will be spent on expenses, so the tax benefits are negligible.

If you have questions about corporate or other startup matters, please contact Benjamin S. Thompson or any member of the Thompson Bukher Business & Corporate Practice at (212) 920-6050.




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