In the wild world of startups, it's not just about your brilliant idea or the tenacity of your team. The structure of your company matters. Choosing between LLC, S-Corp, and C-Corp – these might seem like mere alphabets in a soup, but they represent different legal structures, each with its implications for your startup's future. The question arises - which should you choose?
To unravel this mystery, let's take a closer look at each.
An LLC (Limited Liability Company) offers protection to its owners from personal liability, but its profits and losses pass directly to the owners’ personal income without corporate tax. While flexible, LLCs may not be the go-to choice for venture-backed tech startups as they don't allow for easy issuance of preferred stock, the bread and butter of VCs.
Enter the world of corporations, where we encounter the siblings - S-Corp and C-Corp. An S-Corp is akin to an LLC with its pass-through taxation, but it restricts the number of shareholders to 100, all of whom must be U.S. citizens or residents. Not the most VC-friendly.
Now we turn to the belle of the ball for VCs - the Delaware C-Corp. Why Delaware? Well, it's not for the beaches. Delaware offers a well-developed body of corporate law and a court system that specializes in business issues - the Chancery Court. This makes legal outcomes more predictable, a boon for investors.
C-Corps also fit the bill for VCs in their allowance for different stock classes, no limits on the number and nationality of shareholders, and the potential for a Qualified Small Business Stock (QSBS) tax benefit.
Let's talk about QSBS. It allows for a 100% exclusion on federal income tax on gains from selling C-Corp stocks held for at least five years, subject to certain conditions. Quite the sweet deal, right?
But, remember the phrase 'no free lunch'? C-Corps, and particularly Delaware C-Corps, come with annual franchise taxes. Also, there's the 83(b) election, a vital IRS provision allowing you to pay tax on the fair market value of restricted stock when granted. If you're expecting your company's value to rise (and you should), this could lead to significant tax savings.
Choosing the right business structure is a crucial decision, and it's not something to be done alone. Redbud VC can help. With a robust network of legal experts and a deep knowledge of the startup legal landscape, we can help navigate these waters. Among the trusted law firms we turn to are Cooley LLP, Wilson Sonsini, and Orrick Herrington, which also offers the invaluable Orrick Startup Forms Library as a resource.
Refer back to our previous article "What's the best way to incorporate a tech startup?" for more insights.
In the end, while the Delaware C-Corp may be the star for VC-backed startups, your unique situation and objectives should guide your decision. After all, the letters after your company's name matter far less than what you build under that name.