Why don't investors like to invest in an LLC?


5

I have read that if you are raising money, that an LLC is a dispreferred vehicle for your company.

Why do investors not like to invest in an LLC?

Funding LLC Incorporation Investment

asked Nov 18 '09 at 07:34
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Joseph Turian
895 points
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3 Answers


4

The main reason is the notion of preferred stock. Corporations have it, LLC's and S-Corps don't. VC's want preferred stock so they can:

  1. Control the board by having the preferred stock control more of the company
  2. Setup conditions that allow for favorable conversions for certain events and multiples. This has to do with getting their money out ahead of common stock.
  3. Separate the different funding rounds (e.g. A, B, C).

LLC's also pass through losses every year (like a sole-proprietor) while the S-Corp has limitations on who can own them (e.g. corporations can't own S-Corps nor can foreigners).

answered Nov 18 '09 at 08:41
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Jarie Bolander
11,421 points
  • LLC's don't have to pass through losses. Under the IRS tax rules, an LLC can declare to operate like a sole proprietorship, partnership structure, S Corp or C Corp. (See IRS Form 8832 - Entity Classification Election). – Tall Jeff 9 years ago

2

You might want to compare the various structures available here: http://www.themoneyalert.com/Corp-Entity-Table.html. I would suspect that this difference is the one they aren't comfortable with:

Management Structure

LLC:

Members can set up structure as they
choose.

S corp/C corp:
Shareholders elect directors who
manage business activities.

In short, they have templates for S & C-corps but LLCs require extensive definition ("operating agreements") because they are less implicitly structured.
answered Nov 18 '09 at 08:06
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Dave Rodenbaugh
306 points

1

As Jarie said, the main reason that LLCs are not preferred vehicles for raising capital is that many investors want "preferred stock," which will give them a leg up when the company goes public and all the private stock is converted to public common stock.

Basically, if a company wants to raise VC funding at any future stage, LLC is not the ideal entity type. Normally, startup businesses want to pass through losses in the first years of the business, so they choose an LLC or S Corporation. Then, when they want to get financing, they change to a C Corporation to issue preferred stock to investors.

While it is relatively simple to convert from an S Corporation to a C Corporation tax free, switching from an LLC to a C Corporation can trigger difficult tax issues that require an accountant if the business has bought and sold many assets. This makes LLCs a less optimal vehicle for passing through losses during the startup phase.

answered Nov 18 '09 at 14:27
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Josh Feola
71 points

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