Set up C-Corp now or upon funding?


4

So I'm incorporating my start-up. For now, life is simple (single owner, little to no expenses or income). But if the product gains sufficient traction within the next year or two, I expect to raise venture capital.

Having a C Corporation appears to be a prerequisite for such funding. But it also looks like investors would insist on reorganizing the company for any significant investment anyway (new bylaws, share structure etc).

The question then: Is it easier to reorganize a existing C Corp than to convert an LLC into a C Corporation? If not, I might as well start with an LLC, and save dealing with the lawyers and tax advisers for when an actual deal is being made...

Incorporation

asked Jan 6 '12 at 11:17
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Ejain
163 points

3 Answers


4

If you are comfortable with an LLC, it could be a decent option. It certainly has tax advantages in the short term.

The main drawback of an LLC for a startup is that it will be just painful to add co-founders and generally anyone working for equity. C corps are great for issuing stock-options with vesting. It can be done with an LLC, but frankly if you do, you might as well have done a C corp from the start.

So to me, it's all a question of how likely you are to work alone for more than the coming year. If you expect to build a core team of 2 or 3 in the next 6 months, create a C corp.

There is also one major downside of waiting until funding to incorporate a C corp: you won't be able to issue cheap stock to yourself too close to a funding event.

answered Jan 6 '12 at 11:42
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Alain Raynaud
10,927 points
  • Very interesting answer, and I would love to see this fleshed out a bit. (1) With an LLC couldn't he enter into an agreement with the cofounders concerning their respective ownership following conversion to a C corp.? (2) Concerning the inability to issue cheap stock to yourself, I would think that even if he did this, the investors could essentially undo that as a requirement of their investing in the company. – Kekito 8 years ago
  • (1) yes, but that's what is complicated, non-standard and error prone. Why reinvent the wheel? If you want vesting stock-options, do a C corp. (2) actually, the investors don't care too much, cheap common stock is perfectly normal (the investors get preferred shares that are more expensive). It's the IRS that will complain. – Alain Raynaud 8 years ago

2

You should start as an LLC (limited liability company). That gives you the best combination of liability protection, flexibility, and tax efficiency.

  • LLC
The tax efficiency of an LLC comes from the fact that the LLC is not taxed on its income for federal income tax purposes. Rather, the LLC's income (and losses) pass through to the owners and are reported by the owners. Most states follow this treatment for state income tax purposes. So there is only a single owner-level income tax on the income of a business organized as an LLC.

If you organize the business as an LLC and you need to bring in additional investors later, it is no more painful to add investors to an LLC than to a corporation.

Contrary to popular belief, an LLC can offer equity incentive plans that are more flexible and tax efficient that than stock options or restricted stock plans found in corporations. See http://www.strasburger.com/bios/bio_pdf/Browne-Equity_Incentive_Comp_Plans_for_an_LLC.pdf

  • S corporation
Some advisors recommend an S corporation for various reasons. An S corporation is a corporation that has filed an election with the IRS to be taxed under subchapter S of the Internal Revenue Code. Like an LLC, the S corporation's income "passes through" the S corporation and is taxable to its shareholders. Despite the pass-through tax attribute of an S corporation, I strongly recommend against using an S corporation for a start-up. An S corporation has too many restrictions: only one class of stock, limits on types of shareholders, tax on contributions and distributions of appreciated property to or from the corporation, no tax basis for entity level borrowings, and only limited ability to deliver a stepped up tax basis to investors or buyers. It has no real advantages over an LLC. See http://www.strasburger.com/userfiles/file/Tax%20Strategies/Tax%20Strategies%20Newsletter%20Choice%20of%20Business%20Entity%20Do%20Self-Employment%20Taxes%20Disfavor%20Limited%20Liability%20Companies%20An%20Update(1).pdf
  • C corporation
A corporation that does not elect to be treated as an S corporation (commonly referred to as a C corporatino) is generally the least attractive choice of entity for a start-up. The primary drawback of a C corporation is that it is subject to double income tax: once at the corporation level, and again when the corporation pays out its after-tax earnings as a dividend There are some limited tax benefits for shareholders of C corporations, such as Section 1202 (reduced rate of tax on sales of small business corporations), Section 1244 (ordinary loss on small business corporation stock), and Section 1045 (tax-free rollover of proceeds from the sale of small business corporation stock), these tax benefits generally are not sufficient to justify using a C corporation.

  • Subsequent Conversion of an LLC to a C corporation
Lastly, it is true that some venture capital investors insist that investee companies be organized as C corporations. If you someday find that you need to raise money from an investor that insists that your company be organized as a C corporation (and you cannot find a more rational/flexible money source), an LLC can generally be converted to a C corporation without great difficulty or delay. The conversion from an LLC to a C corporation is a tax free transaction, but all built-in gain at the time of conversion will generally get ensnared in the double tax trap of the C corporation. More enlightened investors should be willing to invest in an LLC.
answered Oct 1 '13 at 07:52
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User28106
21 points

0

LLC are easier to manage than c-corps. Fewer govt requirements. You can easily add cofounders as additional "members" and you can grant 'restricted membership interest" just like stock/options that vest.

answered Mar 20 '13 at 09:04
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Ed B
1 point

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