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LLCs may be better: Inc. Magazine: Don't Let Venture Capitalists Force You To Convert To A C-Corp

This article certainly has me thinking. Have any of you gone this route?

Inc.:Don't Let Venture Capitalists Force You To Convert To A C-Corporation:This all-too-common startup financing mistake can cost founders an astonishing 30% of exit proceeds due to unnecessary double taxation.
  • Most companies never IPO
  • an intermediate blocker entity allows a venture fund to invest in the blocker corporation, which then invests in the LLC

16 Replies

Brent Laminack
1
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Brent Laminack Entrepreneur
Principal at OpenFace Systems, Inc.
S-Corp is the happy middle ground. Money still flows 100% to owner like and LLC, so no double taxation. But you can take dividend income rather than ordinary income and not have to pay self-employment tax as in a C-corp.
Andy Bosselman
1
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Andy Bosselman Entrepreneur
Founder at Arithmetic
I've never heard of an LLC combined with an "intermediate blocker entity." Is anyone familiar with this?

It sounds like an LLC attached to a C-Corp, which would obviously deliver the best of both worlds. It sounds great.
Rick Stratton
0
0
Rick Stratton Entrepreneur
Great States Software / Feed.Us / MKEcribs
It's such a pain in the ass to wait and hope that the K1s get done. That part of an LLC sucks.

Also, paying members any sort of salary (aka "guaranteed payments") can be tricky. Accountants never like it.

Andy Halliday
2
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Andy Halliday Entrepreneur
COO LifeAID Beverage Co.
I reviewed this issue on behalf of a company I advise, talking to CFOs I know and doing some review of the writings of M&A CPAs and lawyers who advocate avoiding the complications of C-Corp status. I concluded that in the case that 1) your company exit is likely to be an asset purchase rather than a purchase of or merging the stock of the corporation, and 2) you don't need to take institutional funding, you can avoid the burden of double taxation by choosing to be an LLC (or S Corp with some limitations on number and type of investors). Bottom line is that if your LLC is a valuation rocket ship, institutional investors will find the (slightly harder) way to invest in you rather than requiring the C-Corp of your entity at the time of investment. The company I advise is thinking of electing to be an LLC now after beginning life as a C-Corp, but there is a tax implication on that conversion (the value of the company now is higher than at the time of the formation of the C-Corp, and the change may trigger a taxable event). An election to become an S-Corp would not trigger that taxable event.
Chip Royce
0
0
Chip Royce Advisor
Sales / Marketing Leader, Generating revenue / profits / scale for technology ventures
I'm a big advocate of S corporations. For a bunch of reasons:
- More likely for a company to get to $25M in revenue. If profitable, could throw off significant returns to stockholders (founders/investors/employees). By being an S Corp, you avoid double taxation on profits.
- Forces large stockholders to treat cash expenditures and profits as 'real money' vs.'play money' (used to fund farsical expenditures like stupid marketing tricks, company parties and culture building atrocities like 'multi-floor slides'
Jeremy Snyder
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0
Jeremy Snyder Advisor
Internationally focused startup biz dev guy
I second Andy and Chip on this. S-corp is a great structure. It's a LLC for legal reasons, but cash-based accounting (easier for everyone) and easy tax treatment.
Andy Bosselman
1
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Andy Bosselman Entrepreneur
Founder at Arithmetic
Does anyone have experience converting a S Corp back to a C corp in the event of a VC raise? It sounds like, if necessary, it's very easy to do that.
Ginger Zumaeta
0
0
Ginger Zumaeta Entrepreneur • Advisor
Integrated Marketing & Content Strategy | Brand Story | Building Marketing Programs that Attract, Retain & Build Loyalty
And adding to Andy's comment. Any experience converting an LLC to an S Corp?
Jeremy Snyder
0
0
Jeremy Snyder Advisor
Internationally focused startup biz dev guy
LLC to S Corporation is as simple was as simple as 1 IRS filing for me. Since an S Corp doesn't change your corporate entity structure but only changes your tax treatment, the only thing I had to do (for a Virginia-based LLC), was to file IRS Form 2553.http://www.irs.gov/instructions/i2553/ch01.html
Chris Murphy
1
0
Chris Murphy Entrepreneur • Advisor
Director of Corporate and Legal Affairs at E2open
For clarification, electing S Corp status is an IRS status *only*, it does NOT affect your legal formation at all. Underneath, you remain the same LLC or Corp you were before the election except to the IRS. It can absolutely be beneficial, but there are also rules and restrictions which must be followed to keep that status.

You can, of course, take in capital as an LLC. However, it typically will involve blocker corps and the like, which have an administrative expense for the VC. This *will* limit the number of VCs who are willing to invest in you. It also means there will be a greater legal fee for the investment, so overall, be prepared to pay a higher transaction cost for the investment, just fyi. Lastly, if an LLC is successful and very profitable, the benefits can actually flip, whereby a C corp at a 35% tax rate is actually in a slightly lower bracket. A nice problem to have, though, obviously.

In short, LLCs can take outside funding, but it's not quite as simple or cheap as when a C Corp. Also, you can elect to be an S corp when either an LLC or a C Corp (and unelect just as easily, btw) without having ANY impact on your legal formation.
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