It seems like every year I see more and more companies that are trying to raise money and are structured as LLCs. It feels like lawyers across the country are recommending an LLC structure for early stage startups. But they’re not asking one important question: “Are you planning on raising professional investment?”
If there were, then there would be more companies avoiding the LLC structure and setting things up as Delaware S corporations that eventually drop their S elections and become C corps. If you are serious about raising money, my advice is usually not to set up an LLC. Set up a Delaware S or C corp.
Of course anything can be fixed, so it’s far from fatal if you do set up an LLC. You can set up a C corp and have it buy the assets of the LLC. It just costs money and time. You end up with less money and the lawyers end up with more.
Occasionally, angels will invest in LLCs, but it’s basically unheard of for VCs. Techstars is an interesting case – we greatly prefer to invest in S or C corporations, but we’ll also invest in LLCs only because it’s not practical to pay to dump the LLC and incorporate the company at a very early stage. But man, can it be a headache. Those LLCs all have to provide K-1s to their investors. This ends up happening at the last minute and delaying personal tax returns for those investors. This sounds like a small problem, but investors who play with LLCs end up spending a bunch of extra time running around at tax time. I’m particularly sensitive to it right now because it’s that time of year. There are other reasons investors don’t like LLCs too. One big example is that they may end up creating tax bills before generating any liquidity.
Bottom line: Assuming you’re not ready for a C corp, create your decision tree based on whether or not you feel that raising professional investment is desired/likely. If so, consider a Delaware S corp for now. This is very easy to change to a C corp. If you don’t plan to raise money, you can get away with an LLC and it may have very real tax advantages for you to do so. As always, consult your (ideally, venture experienced) accountant and/or legal counsel before taking any specific advice, especially from me.
As for why I’m suggesting Delaware, that’s for another post.
UPDATE: I posted More on LLCs two days later as a follow up.