There’s a lot to consider when choosing the best corporate structure for your startup. Should you choose an LLC? What are the differences between a C-corp and an S-corp? While all options have their pros and cons, for the most part, startups should decide to incorporate as C-corporations. This holds especially true if your startup will:

  1. Accept venture funding
  2. Issue numerous and various stock options to investors and employees
  3. Grant equity
  4. Ultimately go public or be acquired

Here’s why incorporating as a C-corp is the golden rule for startups.

If You Want to Grant Equity to Employees

By deciding to register as a C-corporation, it is much easier to reserve shares of company stock for current and future employees. With a business entity like an LLC, providing future employees with equity is much more difficult, writes startup lawyer Doug Bend. Since LLC partners own 100 percent of the business, they would have to sell part of their personal shares to a new employee in order to grant him or her equity. This could trigger capital gains taxes or other financial and legal complications.

If you Want to Raise Venture Capital

Investors seek out startups that are organized into C-corporations for three main reasons:

  • Preferred shares. C-corporations are allowed to issue “preferred shares” of stock in order to raise financing. This class of stock gives special rights to investors, such as anti-dilution protection, conversion rights and the power to elect the startup’s board of directors. LLCs and S-Corps cannot create “preferred shares” for investors.
  • Stockholder rules. C-corporations allow venture capital firms the most legal flexibility when it comes to investing. Because some VCs manage public funds, they are barred from investing in LLCs. And since most venture capital firms are organized as limited partnerships, they are restricted from investing in S-corporations, which require “natural persons” as investors. S-corps also only allow a maximum of 100 stockholders, which limits growth. Thus, by investing solely in C-corporations, VCs can avoid numerous legal entanglements and complications.
  • Taxation. C-corporations have no pass-through tax. LLCs and S-Corporations, however, are not taxed as entities, and company income taxes pass-through to its owners. That means investors could be on the hook for a company tax bill, even if they received zero distributions from the startup, says Invigor Law Group partner Kyle Hulten.

If You Want to Join a Startup Accelerator

You might be considering joining a startup accelerator or incubator to get your business off the ground. Often, these programs view incorporating as a C-corporation as an indication that you are business savvy and ready to begin, writes Bend. Also, many accelerators and incubators take equity in exchange for acceptance, and being a C-corp makes it simpler to distribute shares of your startup.

If You Want Ownership Flexibility

As opposed to an LLC or S-corp, structuring your startup as a C-corp provides you and your startup owners the most flexibility. S-Corps have more stringent rules about who can be owners. As mentioned previously, owners of S-Corporations must be “natural persons” and there cannot be more than 100 of them. They must also be United States residents.

While LLCs do not have such restrictions, LLC owners do not have different ownership options like C-corp owners do, such as dividend participation, liquidation preferences and voting rights, writes financial planning attorney Steve Parrish.

If You Want the Most Growth Potential

From attracting talent to finding investors, incorporating as a C-corporation provides startups with more potential for growth. If you’re serious about structuring a C-corporation, consider doing it in Delaware. Its legal system is attractive to investors and is usually the best place to form a C-Corp. Learn more here.

Once you’re ready to incorporate, post your job for free and get several proposals from expert UpCounsel business formation attorneys who can help you today.

 

Photo: “C-Corporation Basics,” by Aaron George, as seen in LawKick, Inc.

About the author

Alex Liu

Alex Liu

Alex began his career as a scientific legal consultant and then as a journalist researching and reporting on health policy and health sciences. At UpCounsel, he enjoys researching and analyzing data to help businesses make informed decisions. In his free time, Alex is working on a documentary.

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