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What’s wrong with an LLC? (venturebeat.com)
49 points by transburgh on Apr 19, 2010 | hide | past | web | favorite | 18 comments

LLCs are useful entities that fit the needs of many startups.

The main limitations: (1) can't do the equivalent of ISOs and so the options you can grant will always be "non-qualified" (generating ordinary income on the "spread" at the time of exercise); (2) need to do custom drafting, with attendant expense, to mirror standard corporate tools in the LLC context (restricted unites in lieu of restricted stock, preferred units in lieu of preferred stock, etc.); (3) passive investors will wind up paying employment taxes on net income of the venture even though they are not employees (see the lively HN discussion comparing the LLC to the S Corp on this point, here http://news.ycombinator.com/item?id=1063516); and (4) for tax reasons related to their LPs, VCs can't invest in them.

Among the advantages: (1) more informality in management (normally by consensus among members, reflecting the LLC's strong partnership roots); (2) can get tax pass-through without needing to abide by S Corp limitations (with S, can have only one class of stock, can't have foreign shareholders, can't generally have entity shareholders - all of which you can have with an LLC and still get the tax pass-through); (3) can do specialized allocation of losses, which is an important factor for certain investors; (4) can grant profits-only interest to key founders who would otherwise take big tax hit in taking significant equity in an established, high-value startup.

The biggest practical advantage of an LLC is also its biggest practical limitation, and that is that it is like the siren song tempting founders to do quickie, online setups for their startups "just to get started." This is fine for some purposes but can lead to problems if founders use their startup kits to fill out standard templates without taking proper precautions to protect their IP (by failing to capture it for the company), to protect their equity structure (by making sure that founders have to earn their equity over time), etc. In my experience, most of these situations work out without problems but it is wise to get an initial legal consultation in such cases to make sure that, if you take the attendant risks, you do so with open eyes.

The article linked to another one that mentions how in some cases single-member LLCs don't provide protection from personal liability. Is that another disadvantage of LLCs for single founders? Or is the risk of the corporate veil being pierced very small?

Talking with multiple accountants before last setting up my LLC, all said don't think of doing anything but setting it up as a S-Corp with the IRS unless we're going to have huge, yearly losses.

It doesn't seem like it's that many steps there to turn an S-Corp filing LLC into a C-Corp.

Additionally, I do not see why the LLC (Esp an S-Corp or C-Corp filing type) cannot just sell itself to a newly founded C-Corp.

I think it can, but the sale counts as a liquidity event, which means the LLC's members must pay taxes on the income they derive from the sale. That's why you have to get bulletproof tax advice. In addition, there may be issues with securities laws, so you also need an expensive lawyer experienced in dealing with this problem.

Securities laws are mostly about the sale of public companies and the purchases of public companies.

LLC conversion to C-Corp can be done (we did it), but it was certainly a headache. Letting our lawyer and CPA take care of everything but our signatures was well worth the money.

Which state? Did you like the job they did? Want to share their names?

California. Alan Lewis is our lawyer (alan@alanlewislaw.com) and Alan Watters is our CPA (awatters@krohngodby.com). No complaints working with these guys and they're not terribly expensive (relatively speaking).

Despite asking dozens of people and reading hundreds of articles over the years, I have literally never heard the same explanation of LLC's, S-corps, C-corps and related tax, liability and paperwork infrastructures twice.

I notice that whenever this is a discussion about LLC, the supposely downside is always that the VC's prefer a C-Corp and therefore if one wishes to eventually take VC money, then one should be proactive and not form an LLC. That is simply not true and has not been my experience. It is true that the VC's prefer C-Corp but they never insist on investing in companies that are C-Corp. The best way is actually for the entrepreneurs to form an LLC to take advantage of the tax structure and flexibility, then when you are ready to take VC money, just let them form a C-Corp and acquire your LLC. It is not complicate and don't let any lawyers/accountants tell you otherwise.

For anyone with concerns about business structure, I highly recommend "The Entrepreneur's Guide to Business Law"--while it doesn't cover all of the tax implications of each structure, it is a great general reference for LLC vs. S-Corp vs. C-Corp (and a myriad of other topics).


Be warned, though, that neither alternative is generally appealing to investors.

So what kind of corporate entity would be appealing to investor?

C corp; it's just that getting there from the questioner's LLC may be expensive/cumbersome

We're going through this right now ("converting" an LLC to a C-Corp to make VCs happy).

It's not hard, not expensive, and not cumbersome. We're creating a new C Corp, and making the old LLC a subsidiary of the C Corp. It's common and standard and it's about 5% of the paperwork that lawyers do to close a Series A round. It's basically the easiest part of our financing.

Don't worry about starting your company as an LLC. If you don't take VC, you'll be MUCH happier with an LLC than a C Corp, because it avoids double taxation in many scenarios.

The best of both worlds is to start as an LLC and only convert to a C Corp when and if you take Series A financing, in which case you'll be doing so much paperwork the conversion will be the least of your worries.

What is hard or expensive about converting an LLC to a C corp? Assuming two 50/50 partners in a simple California LLC.

frankly I don't see why with all the innovation web startups introduced, and just the sheer number of them in existence(has to be millions at this point)...that the government hasn't designed an entity specifically for web based companies.

> that the government hasn't designed an entity specifically for web based companies.

What recent experience with govt have you had that suggests that such a thing would be a good thing?

General rule: The desirability of a solution with certain properties has nothing to do with whether a solution with those properties is possible, let alone likely.

In other words, the benefits that we'd get from govt doing {whatever} well have nothing to do with whether govt is likely to do said {whatever} well.

Startups are too busy innovating to be lobbying/donating?

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