I once sat in on a meeting between a public company client and an investment banker, from whom the client wanted an underwritten offering. At one point in the conversation the CEO of my client said something like, “We intend to structure our business in accordance with the requirements of Wall Street.” Nobody twitched. But this is not going to be a post on the absurdity of taking unsound actions to appease Wall Street, it is a post about being realistic about how you cater to your financing sources. 

I don’t even know how often I get calls asking whether some entrepreneur should structure his business as an LLC or a “C” corporation. When I get this call, I want to talk about the tax distinctions between the two forms of organization (an LLC is actually a partnership for federal tax purposes and therefore a “pass-through entity”, and a “C” corporation is a taxpayer). I want to talk about what happens when you have losses and when and how they can be used to offset other income (and the type of income they can be used to offset – see my post on LLCs). I would like to talk about flowing cash up and not having double taxation. I would like to talk about reinvesting profits into the business and other factors to be considered in a choice of entity. 

But, somewhere early in the mix of the conversation has to be the question; “Who are going to be your investors?” If the answer to this is, “I plan to raise venture capital from a name brand VC.” Then, there is really only one way to go. You must be organized as a “C” corporation. 

Name brand VCs (by which I mean firms such as Atlas, Polaris, Charles River and their ilk) invest almost exclusively (actually exclusively?) in “C” corporations for tax reasons related to their own structure and the types of entities that invest in venture funds. These types of venture funds are typically structured as limited partnerships (which are themselves pass through entities). Some of their investors are tax exempt organizations such as pension funds. If income from a taxable entity is passed through to these types of entities, they have “unrelated business taxable income (“UBTI”). This creates a tax problem for the pension funds. Creating tax problems for their investors in anathema to the venture funds. For this reason, they need to invest in entities that do not pass income through – hence “C” corporations. 

OK, so what if I start out in life as an LLC and then switch to a “C” corporation? You should also check out my post on this topic. The short answer is that, while it is really easy (from a mechanical point of view) to switch from an LLC to a “regular” corporation, the tax consequences can be deadly and dealing with them can be very complex (read expensive and time consuming). So, unless there are some very material benefits, you want to think twice, three times, no four times, before you take this path.