I'm not sure those are particularly compelling reasons.
Of the "12" reasons given here, fully 6 boil down to "investors don't like LLCs". This, of course, is true. What the article doesn't go on to say, but maybe should, is that "investors don't like C corporations either". Whether you're an LLC or a C-Corp, the odds as I grok them are pretty good that your first institutional VC investor --- should you ever close a round of financing --- is going to build a rewrite of your corporate structure into the closing cost of the round.
Of the remaining 6:
* Reason 3 requires us to stipulate that the LLC agreement, for some reason, prohibits reinvestment of income into the company. You could design an LLC agreement that did that, but why would you?
* Reason 8 suggests that there is a specific case where your LLC is acquired in which there's a tax advantage to not being an LLC. Ok.
* Reason 9 argues that LLC agreements are harder to draft than corporate documents. I think this is probably just false. Certainly, the legal costs of setting up a C Corp are higher than those of an LLC, which most people set up without legal help at all.
* Reason 11 suggests that because LLCs are defined by membership agreements, which are just contracts, they can get hairy. This is a generalization of reason 3. It again requires us to stipulate that the members of the LLC have elected to complicate their membership agreement. Who does this?
* Reason 12 says that Section 1202 and 1045 rollover benefits aren't available to LLCs. OK, then.
* Reason 6 says that equity comp in an LLC is more complicated than that of a C- or S- corporation. This, as far as I understand it, is actually true. You can provide employee equity compensation in an LLC (we did), but it's not as flexible as what's available in a C Corp, which can have multiple classes of shares.
There is probably a lot of validity to these 6 points that I am missing because I'm not a lawyer. I just don't read them and see things that would have impacted my last company --- an LLC, and a decently big one --- operationally.
I feel like I often sound like a cheerleader for the LLC. I'm not. But it's cheap and easy to set up an LLC, and it's really not all that easy to set up a C-Corp. To my mind, the most important benefit of having a corporation is the ability to enter into corp-to-corp contracts, which is a problem LLCs solve just as well as C-Corps, with less drama. From what I can tell, plenty of corporations start off as LLCs and then convert to C-Corps when they raise money.
People should probably do the simplest thing that can possibly work, rather than spending thousands of dollars on corporate structure for a business that (like all businesses) is more likely than not to fail in its first year.
LLCs are great for the sole proprietor, which is tptacek's primary experience.
If you don't need outside money, and you don't need co-founders, sure, LLCs can be good enough. Their best use is for BIG-CORP subsidiaries, which is nearly the same as sole-proprietorship activity. Simple: one owner controlling everything, and uncomplicated capital structure.
It's really not that hard to set up a C-Corp, there are millions of them and because of that they are well understood. Compared to LLCs, if there is outside money or multiple founders involved, C-Corps avoid some issues: founder vesting and ownership-options are a challenge to draft well in LLCs and are well understood in C-corps; multi-class stock is pretty straight-forward in C-corps.
Thanks, I stand corrected on your prior participations. Proprietor was too narrow a term, and better that I had said that it represents an example of the larger case where outside participation is simple, or non-existent.
These are the relevant quotations. If one has simple capital structure and do not desire to structure non-cash employee incentives, and have no need for new rounds of investors who might make new structural demands that conflict with prior agreements of LLC present member/owners, then the LLC is good enough.
Quotations:
6 – Equity Compensation - Equity compensation in entities taxed as partnerships is much more difficult, complex and expensive to draft and administer than equity compensation in a C or S Corporation. For example, to grant profits interests in an LLC, it is typically necessary or advisable to “book up” the capital accounts of the owners prior to granting the profits interests, and this must happen at each award. If there are successive rounds of equity grants each year, these books-ups can become very expensive and time consuming. This same complication occurs with options or warrants to acquire LLC interests.
7 – Raising Capital - Raising additional capital through an LLC is much more difficult than raising a next round through a corporation. LLC agreements are more difficult and complex to prepare than their corporate counterparts. In addition, you can hit upon sticky and highly complex tax issues in the LLC context that just don’t exist or arise in the corporate context.
(We might be the only two people reading these comments.)
I agree that equity compensation is a headache in an LLC compared to that of a C-Corp. But I'm not sure how much money we really had to spend to do it.
I do not agree that having an LLC will meaningfully impact your funding. Obviously, nobody is going to fund an LLC. But you'll work out terms on the premise that you'll do a conversion or reincoporation/merger, and the legal for doing that will be part of your closing costs. Friends who have gotten funded under a C-Corp have told me they had to do this anyways, because VCs wanted the corporation on their paper anyways.
It's a little bit like saying that nobody will fund an actual sole proprietorship. That's true, they won't. But they'd prefer it if you came to them in that form! Because that's the cheapest corporate form to convert to their preferred form.
Of the "12" reasons given here, fully 6 boil down to "investors don't like LLCs". This, of course, is true. What the article doesn't go on to say, but maybe should, is that "investors don't like C corporations either". Whether you're an LLC or a C-Corp, the odds as I grok them are pretty good that your first institutional VC investor --- should you ever close a round of financing --- is going to build a rewrite of your corporate structure into the closing cost of the round.
Of the remaining 6:
* Reason 3 requires us to stipulate that the LLC agreement, for some reason, prohibits reinvestment of income into the company. You could design an LLC agreement that did that, but why would you?
* Reason 8 suggests that there is a specific case where your LLC is acquired in which there's a tax advantage to not being an LLC. Ok.
* Reason 9 argues that LLC agreements are harder to draft than corporate documents. I think this is probably just false. Certainly, the legal costs of setting up a C Corp are higher than those of an LLC, which most people set up without legal help at all.
* Reason 11 suggests that because LLCs are defined by membership agreements, which are just contracts, they can get hairy. This is a generalization of reason 3. It again requires us to stipulate that the members of the LLC have elected to complicate their membership agreement. Who does this?
* Reason 12 says that Section 1202 and 1045 rollover benefits aren't available to LLCs. OK, then.
* Reason 6 says that equity comp in an LLC is more complicated than that of a C- or S- corporation. This, as far as I understand it, is actually true. You can provide employee equity compensation in an LLC (we did), but it's not as flexible as what's available in a C Corp, which can have multiple classes of shares.
There is probably a lot of validity to these 6 points that I am missing because I'm not a lawyer. I just don't read them and see things that would have impacted my last company --- an LLC, and a decently big one --- operationally.
I feel like I often sound like a cheerleader for the LLC. I'm not. But it's cheap and easy to set up an LLC, and it's really not all that easy to set up a C-Corp. To my mind, the most important benefit of having a corporation is the ability to enter into corp-to-corp contracts, which is a problem LLCs solve just as well as C-Corps, with less drama. From what I can tell, plenty of corporations start off as LLCs and then convert to C-Corps when they raise money.
People should probably do the simplest thing that can possibly work, rather than spending thousands of dollars on corporate structure for a business that (like all businesses) is more likely than not to fail in its first year.