Why a C-Corporation? Why not an LLC?
The short answer: C-Corporations are the company type nearly all investors prefer to invest in. C-Corporations are also well-suited to a high-growth startup’s business needs.
Investors and funds work with many companies at a time. For decades, these have primarily been Delaware C-Corporations, so the whole venture system is built around the assumption that any funded company will use that structure—including all of the agreements, structures, accounting, and tax rules. Venture capitalists and startup lawyers have developed standardized contracts and best practices for C-Corporations to handle multiple founders, investors, and employee-shareholders.
Investors also prefer C-Corps because their shares are usually eligible for the Qualified Small Business Stock tax exemption, which offers a very substantial reduction in the taxes investors (or founders) will have to pay on shares of the company if it’s successful. This exemption is not available for S-Corps, LLCs, or any other entity besides C-Corps.
Limited Liability Companies (LLCs) have many appropriate uses, but for the modern high-growth startup, they are not ideal. For one, the tax rules governing LLCs significantly complicate equity, since they don’t have an included “shares” mechanism but treat every co-owner as a partner. Setting up a high-growth startup as an LLC also generally requires expensive custom legal drafting, which can cost a lot and introduce difficulty. Many venture funds can’t invest in LLCs because of their tax treatment. The venture community knows this, so just as they choose Delaware as a state, they will also insist on working with C-corporations.
Most companies that initially form as LLCs generally are required to convert to C-corps, at considerable cost and delay, as a condition for obtaining funding from angel and venture capital investors. While LLCs (and S-Corps) may be beneficial to a founder whose business will generate a lot of cash in the short term, the savings if any will usually be outweighed by the cost of conversion. For most high-growth startups, these considerations make the Delaware C-Corporation the entity of choice.
Last updated on June 28, 2018