The rise of the LLC

In startup land, the C-Corp has reigned supreme for a number of reasons, but largely because venture capitalists simply won’t invest in anything but a C-corp.

Background: For a general overview of the benefits/costs of LLCs v. Corps, I usually forward these two articles to our clients: Choice of Entity and What Type of Entity Should I Form? And if you want a simple argument in favor of C-Corps, try Top Reasons to Choose a C-Corp.

All of the above articles provide very good analyses on the legal and tax nuances of the two entity types, but at the end of the day, the real push for someone to use the LLC form is very simple: a single layer of tax without the handcuffs that S-Corp status places on your equity structure. Corporations have two layers. And the real pull away from it is just as simple: VCs only invest in Corps.

In our practice group, we’ve definitely noticed an uptick in the number of entrepreneurs choosing to start as LLCs from the get-go, notwithstanding the fact that our standard start-up fixed-fee package (quite popular) doesn’t apply to LLCs.   This would suggest that something related to the push/pull factors has changed.

The logical explanation for this trend would be unsurprising to anyone who follows the funding environment in the startup ecosystem :

  • Starting & running a startup keeps getting cheaper
  • Bootstrapping is therefore possible for much longer
  • Angel investing has become hip, so more early-stage non-VC capital
  • Strategic investment in startups from established companies is also on the rise

In a nutshell, these trends allow startups to last for longer periods of time without having to raise money from venture capitalists.  Angels and strategic investors are generally not LLC-averse.

If you plan on raising VC money in 6 months after formation, then the tax benefits of an LLC are pretty much null, especially when you factor in the cost of conversion at funding.  But for a number of companies who can now expect to operate for years, generate revenue, and even turn a profit well before raising a traditional Series A (if ever), the cost-benefit analysis of LLC v. Corp has changed.

C-Corp is still king, as it still should be for most tech startups, but the LLC is increasingly gaining credibility as well.  In the legal field, repetition is the mother of efficiency.  As more LLCs are formed, standardized docs will emerge, and the gap in legal costs between forming an LLC v. a C-Corp will continue to shrink.

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