Selecting a legal entity for your business can be such a frustrating experience! Clients often come to me wanting to know what type of legal entity is a good fit for their business needs. Typically, they have done some research that involves reading all about LLCs, S-Corps, C-Corps, Benefit Corporations, LLPS, LP, GP, LLLPs and they feel overwhelmed by all the legal entity options! Well, guess what? Usually, if you are a startup looking to raise venture capital, the likely answer for you will be to go with a C-Corporation!
Why not the trendy LLC? For the most part, LLC’s are fairly new entity structures compared to the traditional corporation. Therefore the laws surrounding LLC regulations aren’t as extensive as the laws that exist for corporate governance and related stockholder rights. Most VCs enjoy some degree of predictability, and LLCs are too new to provide such extensive predictability like corporate law can. Also, taxation in LLCs can lead to mini minefields for VC firms and some even have restrictions against LLC investments written into their firm provisions.
A next question is, why not that amazing S-Corp? An S-Corp can definitely have advantages for an early stage company, but it also comes with plenty of limitations that makes it difficult for VCs to join the fun. For example, S-Corps may only have one class of stock. As you know, VCs love their preferred stock and they will likely demand it- so this simply won’t fly. Also, S-Corp stockholders can not have more than 100 stockholders and its stockholders must be natural persons. Although some exceptions apply, this imitation will not allow for venture investment because most venture capital firms are set up as Limited Partnerships. Then, as your company grows due to your awesome hard work and continued success, you will hit a bump with the 100 shareholder cap when your startup decides to hire new employees and issue stock.
Bottom line: Sometimes an oldie is still a goodie. A C-Corp seems to outpace the other entities for startups looking to attract venture capitalists to join their road to startup success.