Venture capital · Incorporation

Is starting out as an LLC problematic for funding?

Patrick Cohen Founder @ Rensix. Connected car accident forensics

October 23rd, 2014

I know that institutional investors usually require that the company they invest in is organized as a C-Corp. However, to keep overhead to a minimum in the beginning, I would prefer to start out as an LLC.

Does anybody know if it is problematic to switch from LLC to C-Corp later on?
For example, would this create large additional costs? Or do incubators and small institutional investors shy away from companies that have yet to reincorporate as a C-Corp? Are there any other potential issues with this approach?
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Retail Tech Founder

October 23rd, 2014

Accelerators and institutional investors will almost all require you to be a c-corp. The reason is that an LLC can put almost anything in it's operating agreement and isn't subject to the same kind of standard investor protections the state grants to c-corps. That means an investor has to diligence the operating agreement carefully (which they don't with standard incorporation) and any non-financial terms they negotiate will require a legal change in the operating agreement. I don't think c-corps are substantially more expensive to incorporate - the only reason I've seen to use an LLC structure instead is if you're putting a substantial amount of money into the company yourself and want to use the pass-through losses to offset other income for tax purposes. I actually did that with my last company, and then converted to a c-corp before we did our first institutional round. It's a bit of a pain though, so if you're not getting the benefit of tax offsets it's probably not worth it. Carrie Mantha Founder/CEO, Indira @CarrieMantha What are we up to at Indira? Sent from my iPhone, kindly excuse typos

Bill Brown CEO, NET Power | Co-Founder, 8 Rivers Capital | Innovation at Industrial Scale

October 23rd, 2014

LLCs are OUR preferred mechanism. 

I am not a big believer in the C corp mythology. There is so much more value that LLC loss passthroughs can bring to your investors. In addition, LLC "profits interests" are an important mechanism for compensation. 

In any event, the defining event for conversion to C corp is when you flip from loss mode to gain mode. In a world where most companies are not immediate home runs, too much value is lost in adopting a C corp and denying the tax benefits to investors.   The issue for VCs is twofold: wanting to avoid attributed taxable income and wanting to avoid unrelated business income for those funds who have investors who care about that. 

Let's face it, passthrough is the rule for "normal" investment vehicles such as hedge funds and mutual funds.  And, there are so many structures that can work with and LLC and eliminate passthrough if desired. 

We are finding this is mostly a lawyer comfort issue. The ones who routinely deal in the world of LPs and LLCs understand how to navigate. Those who only know C corps stay in that space. 

Good piece on profits interests


Prevalence of profits interest and explanation of its recent growth in popularity.


Just to be clear, I am not a tax advisor, and nothing above should be construed as tax advice. Please check your own advisors to get advice that is appropriate to you and your situation. 


Scott Milburn Entrepreneurial Senior Executive and Attorney

October 23rd, 2014

As some have suggested, unless you are going to see actual investors (as distinct from lenders with convertible notes) any time soon, then starting with an LLC makes the most sense. It is easier to form and manage, and cheaper. As far as conversion, that depends on the state. For example, Washington State recently make it very easy and inexpensive to make the conversion. So, most likely, if you are not getting investors soon, the LLC is the best choice short term.

As an aside, you will hear lots of comments that you have to be a DE corporation. Just so you know, there is really no true justification for that perspective other than the typical lawyer approach to things of "this is just how it is done." It is the same reason lawyers always write dollar amounts as "four hundred twenty eight dollars and no cents ($428.00)." There is absolutely no need or reason to do that other than "that is how we have always written number since some obscure case 150 years ago."

Mark Koffsky Partner, Koffsky Schwalb LLC

October 25th, 2014

I almost always advise my clients to start with the LLC in their home state. Keeps things simple and allows you to immediately deduct business losses (and therewill be plenty). Converting to a Delaware C Corp later is relatively simple and doesn't need to be done until someone tells you they want it done before they invest in your company. An investor is buying you and your company not your legal entity. No one is going to walk away only because you are an LLC.

Biz/Product/Marketing

October 23rd, 2014

Hi, I have been through the LLC to C-Corp conversion issue before and it was not worth the money saved on the lower cost of an LLC.  There are both legal and tax implications.  I was able to get a good read out by lawyers but there was a variance of opinions from tax people on how to handle since an LLC overlaps with your personal tax filings.

In the long run I spent more than if I just set up an LLC even with a lot of free legal/tax advice from experts.

To answer your other question, most VC's and investors don't want an LLC.

Anonymous

October 23rd, 2014

Honestly, I think it depends. I'd try understanding the pros and cons of both if I were you. As for investors, if you're raising funding from VCs soon, just save yourself from all the hassle and go with a C Corporation (maybe even electing to become an S Corporation) straight from the get-go. However, if raising VC money isn't on your radar for a while, it's okay to go with an LLC. The idea that *all* investors (or even a majority of them) require a C Corporation isn't necessarily true. You can get angel convertible notes just fine with an LLC. If you do decide to go with an LLC, though, be sure you understand how the conversion will work for that state when you want to convert to a C Corporation (preferably in Delaware) later.

All in all, talk to a lawyer and get a good firm to work with you.

- Jonathan

Sean Hurley Strategic Marketing Leader with strong financial results for growing organizations

October 23rd, 2014

I would save your money and when you need investment, fold the cost of converting to a S or C corp into the use of funds...When are you planning to raise money? --- Sean M. Hurley, Founder & CEO Hurley Associates Growth Partners www.hurleyassociates.net 617-784-1435 sean@hurleyassociates.net "Helping Creative Entrepreneurs Bring Exceptional Products To Market"

Derek Bereit Startup founder || python neophyte, NY attorney, veteran || general counsel Nimbo || co-founder Symptomly | Techstars

October 23rd, 2014

(1) LLC will not scare off investors/incubators.

(2) They will require a conversion.    This will likely be one of many clean-ups your lawyer will help with upon funding!

(3) Starting with Delaware C-Corp will signal you know what you are doing and you planned to be raising funds in future...

Ritesh Agrawal Product Management, Sr Director [Hiring PLMs/TMEs - Network Security & Strategy]

October 23rd, 2014

Start with LLC - low overhead and low cost. Once/when you grow to be big (raise $$, start getting significant revenues, or build a huge team), get the LLC acquired by a newly formed C-Corp (could be same company name). If you started with C-Corp on day-1, you'd be investing lots of $$ and time managing the entity that doesn't add additional value to your business. Ritesh

Michael Brill Technology startup exec focused on AI-driven products

October 25th, 2014

But it's not just about investors. You want to get an advisor? Now you have to construct an agreement that address the LLC equity and how it will convert to corporate equity later... and then try to tell them the story. Same thing for early employees, co-founders, etc. It's just sand in the gears if you really think you're going to try to raise professional money.