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LLC, C-Corp, or S-Corp for tech startups?

I am wondering what is the best structure for a tech startup in New York City. Especially keeping in mind that the future will entail being capital intensive requiring outside capital for execution.

33 Replies

Mike Moyer
2
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Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
  • Form an LLC with a Slicing Pie equity agreement for founders and early participants.
  • Give angel money convertible notes or a SAFE.
  • Convert to a C-corp at Series A.
Peter Weiss
5
0
Peter Weiss Entrepreneur
President at American Outlook, Inc.
If you are going to need substantial equity infusion(s) start and stay a "C" corp.

If you are based in New York City and choose LLC (assuming pass-through tax status, the main reason for using an LLC) all investors will receive K-1s and likely will have to file New York State and City returns and pay taxes on the allocated income, whether or not you have done cash distributions to cover the obligation. For smaller investors the cost of the tax return alone can be a disincentive.

There are operational and financial reasons to avoid unnecessary conversions from LLC to corporation. While the conversion is relatively simple from a legal and tax perspective you will have a new EIN/TIN which means you need to reopen or restart bank accounts, insurance policies, credit histories, ratings based accounts like unemployment or workman's comp, etc. You will also have to change "LLC" on all your webpages, printed materials, business cards, etc. to "Inc."

One of the most important reasons for being careful about conversion is that when you become profitable, you will have no tax loss carry forwards to shelter your first taxable income which means you will probably need to find additional capital to the extent you have to pay taxes sooner. For example, if you lose $2 million prior to profitability and pass the losses to the LLC owners, when you convert you will have foregone $2 million in offsets to taxable profits. At a combined 40% tax rate (and in NYC it might be higher) that's $800,000 in taxes the company will pay rather than retaining for working capital or investment in future growth.

LLCs are great for companies that will not need may equity infusions and are expected to generate lots of free cash flow but they are best used in situations where the structure can be relatively stable.
Vanessa Kruze, CPA
0
0
Vanessa Kruze, CPA Entrepreneur
Startup CFO Consultant
If you'e thinking about raising capital form VCs or angels you must be a DE CCorp. Must must must! If you're a traditional small business or service business, then do the LLC or SCorp route.

Can you start off as an LLC... yes. Just know that there will be legal and accounting fees associated with the conversion to a CCorp. We've worked with 200+ startups and seen these types of conversions 6 times. It happens, but its relatively rare.
Darius Lahoutifard
0
0
SaaS, Cloud, Enterprise Software, International Sales, Global Sales & Marketing, Growth, 3D, VR
I've always gone with a C-Corp from day one, being sole Board member, sole director. Doesn't cost more than LLC, while no conversion needed when you want to raise money.
I'm curious Mike, what downside do you see with starting right away with a C-Corp when you know you'll need to being in investors? Or what benefit of a LLC vs. C-Corp in this case? Conversion costs money.
Terri Friel
0
0
Terri Friel Advisor
CEO Doctus and Member International Advisory Board of Cracow School of Business CUE at Cracow University of Economics
I guess my question would be more about what form best protects me and partners from risk. It's a legal question I can't answer but suspect in tech the risk of damage etc is higher and thus the C corp is best from that perspective. Not sure why Mike says to start as LLC then shift...I'd love to hear the rationale for that approach.
Olivier Attia
0
0
Olivier Attia Entrepreneur
Serial Entrepreneur in NYC
Check our FAQ on the subject at gershonconsulting.com/faq.
Peter Weiss
1
0
Peter Weiss Entrepreneur
President at American Outlook, Inc.
One more challenge with the LLC conversion: if the company has a negative net worth when you do the conversion the LLC owners have attributed taxable income because the LLC's obligation is extinguished when the corp assumes the liabilities. For example, if the LLC has $1 million of notes and accounts payable which are assumed by the new corp, as the LLC closes its tax books that $1 million becomes income to the owners. Using a blended 40% tax rate, this means writing tax checks for $400,000 without receiving cash.

You can solve this problem by converting the debts to LLC units prior to conversion but the requires multiple steps and cooperation from the creditors. It is workable with convertible note holders but difficult with trade payables.
Gabriel Moncayo
0
0
Gabriel Moncayo Entrepreneur
CEO & Co-founder at AlwaysHired | Top 25 AA-ISP Inside Sales Professional
C-Corp. We were LLC and had to convert to C-Corp for our raise. *Gabe Moncayo* [ o ] [removed to protect privacy] [ e ] [removed to protect privacy] [ w ] www.linkedin.com/in/gabemoncayo "Whether you think you can, or you think you can't - you're right."
David Austin
0
0
David Austin Entrepreneur
Entrepreneur
Like Mike said. That is conventionally the best recommended practice.

You'll want LLC for the tax advantages and simplicity when it's just you or your team. When bringing on some investors (more that 5 for example) an LLC will start to become unmanageable ... the more the investors = the more unmanageable. That, and depending on the investment you may be legally required to do an C-corp. Try to stay an LLC as long as you can though before that, even if you're doing crowdfunding (but not equity crowdfunding). Many investors will require to you do a C-Corp.

One way to do it which has advantages is when you're ready to bring on investors to your LLC, make one member of the LLC a C-Corp (a separate corporation), then all investors would fit within the C-corp. Through the C-Corp then you enjoy all the advantages of of a C-Corp, and can apportion business costs to the right business structure (usually the LLC). This can save a lot of money (alleviating some of the problems like double taxation of a C-corp ... though at the sell of an LLC investors will see double taxation ... they should be used to that).

In other words, if you want to raise $300,000 for 25% of the company, create a separate C-corp, Investors Inc, to which you issue 25% of your stock. Investors buy stock in Investors Inc, not your LLC (of which Investors Inc is a member).

Talk to your lawyer.
Mike Moyer
1
0
Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
Hi Darius, I like to start with LLCs because it allows you to allocate losses however you want. The cash investors should get the losses regardless of the equity split an LLC makes this easy. And, most companies fail so there's a good chance that all a company has is losses! -Mike www.SlicingPie.com
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