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Question added to topic MarketingOctober 29, 2009

What's the best corporate structure when seeking funding from VCs?

I am starting a business that will require fund raising from friends and family, as well as angel investors and VCs. I would expect that the funding will be guaranteed with company equity. Should I incorporate as a C corp., allowing me to distribute large shares to investors, but retain majority stake and control?
Actually, when we launched our business we asked ourselves the same question. Simply stated, C Corporations are the best option for any entrepreneur seeking funding from angel investors or venture capitalists.

From an administrative perspective, when entrepreneurs need to raise multiple rounds of funding via angels and VCs, they will need to issue several classes of common and preferred stock--and that is best managed in a C Corporation. Moreover, if you have any intention of issuing employee stock options at some point, incorporating as a C Corporation is your best bet.

Another point to note is that most angels and VCs prefer--and sometimes can only--invest in C Corporations. This is due to a few reasons. For starters, the pass-through (income/expenses) features of, let's say, an LLC, are not desirable to VCs because it creates unrelated business taxable income (UBTI) and can cause their foreign limited partners to file a U.S. tax return.

Secondly, VCs prefer a corporate structure in which you can easily transfer membership interest--this is only feasible in a C Corporation.

Thirdly, VCs have historically invested in C Corporations because they're familiar. As a legal entity, the C Corporation has been in existence for decades so the corporate governance and shareholder rights laws are very well know--more so than any other corporate structure.

Finally, many VCs have specific provisions in their organizational memorandums that restrict them from investing in an entity other than a C Corp.

Hypothetically, you could launch as an LLC or some other corporate structure now and switch later on, but it is expensive. Attracting angel or VC backing is hard enough, so why push the envelope with a corporate structure other than a C Corporation which is funding-friendly?

In closing, I understand that incorporating as something other than a C Corporation (i.e., an LLC) can be more tax advantageous when you launch your business. But if you truly have your eyes set on obtaining angel and/or VC funding, C Corporation is the way to go.

Ryan Himmel, CPA and registered securities analyst, is the founder and CEO of BIDaWIZ.com, a professional network for small businesses and entrepreneurs to obtain trusted advice and services from a team of CPAs, Enrolled Agents, Financial Planners & Tax Attorneys.  His team provides answers to the many finance and tax questions that small businesses encounter every day. Ryan has been quoted in The Wall Street Journal, Forbes, Fox Business and Crain's New York, among other publications. Ryan also regularly contributes to the community with his finance and tax blog.

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