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Seeking Venture Capital & Unsure Which Legal Entity to Setup?
By The BIDaWIZ Team - October 31, 2009
We recently received the question as to what is the best legal entity to setup if seeking angel investors & venture capital.
Best Option = C Corporation
Simply stated, C Corporations are the best option for any entrepreneur seeking funding from angel investors or venture capitalists.
From an administrative perspective, when entrepreneurs need to raise multiple rounds of funding via angels and VCs, they will need to issue several classes of common and preferred stock - and that is best managed in a C Corporation. Moreover, if you have any intention of issuing employee stock options at some point, incorporating as a C Corporation is your best bet.
Venture Capitalists/Angels Prefer C Corporations
Another point to note is that most angels and VCs prefer - and sometimes can only - invest in C Corporations. This is due to a few reasons. For starters, the pass-through (income/expenses) features of, let's say, an LLC, are not desirable to VCs because it creates a unrelated business taxable income (UBTI) and can cause their foreign limited partners to file a US tax return. Secondly, VCs prefer a legal entity in which you can easily transfer membership interest - this is only feasible in a C Corporation. Thirdly, VCs have historically invested in C Corporations because they're familiar. As a legal entity, the C Corporation has been in existence for decades so the corporate governance and shareholder rights laws are very well know - more so than any other legal entity. Finally, many VCs have specific provisions in their organizational memorandums that restrict them from investing in an entity other than a C Corp.
Tax Advantages of an LLC Can Be Distracting
Hypothetically, you could launch as an LLC or some other legal entity now and switch later on, but it is expensive. Attracting angel or VC backing is hard enough, so why push the envelope with a legal entity other than a C Corporation which is funding-friendly?
In closing, we understand that incorporating as something other than a C Corporation (i.e., an LLC) can be more tax advantageous when you launch your business. But if you truly have your eyes set on obtaining angel and/or VC funding, C Corporation is the way to go.
More Tax Law Questions?
If you have additional questions, our Tax Law Wizards are Here to assist.
Have Comments? Write to comments@BIDaWIZ.com
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