Have a great idea and plan on starting a business? Think you might want to raise venture capital at some point in the future? Better think twice about forming an LLC. Venture Capitalists tend to require a “C” corporation when investing in a business. Why? Good question. Here are some reasons:
- Venture Capitalists like preferred stock, they are familiar with preferred stock, and will usually have already perfected terms for preferred stock.
- Venture Capitalists typically don’t care about / don’t want pass through losses from an LLC.
- Venture Capitalists will invest with an exit strategy in mind. That exit will likely either be an IPO, which is generally only available to “C” corporations, or sale of the company, which would preferably occur via a tax-free reorganization. Only corporations can participate in tax free reorganization.
So why not an “S” corporation? Two main reasons. First, “S” corporations, under most circumstances, may not have a shareholder that is not a natural person; most Venture Capital funds are organized as limited partnerships. Second, “S” corporations may not have more than one class of stock. As I mentioned above, Venture Capital funds love preferred stock, and they can’t get it from an “S” corporation.