Why Your Startup Should (Likely) Be A C-Corp
June 9, 2014 | By Kevin Vela
UPDATE: This blog was formerly titled, “The Delaware C-Corp Myth.” However, with the passing of the Tax Jobs and Cuts Act of 2017, a C-Corp makes sense for more startups than ever before. Because of the decreased corporate tax rates, the tax consequences of a C-Corp are no longer as consequential in comparison to an LLC, and a C-Corp’s ability to scale, as well as the widespread preference by venture investors now trump the much smaller tax burden. Thus, I’ve fallen in line with the vast majority of venture attorneys and am actively recommending C-Corps for startups.
Despite what you read, Delaware C-Corps are not for everyone.
We represent a lot of startups here at VW. And more often than not, founders come into our office certain that they need a Delaware C Corp to launch their business.
That’s simply not the case. Every startup should take great care when deciding choice of entity, because one size does not fit all.
Yes, if you will be a venture backed startup, then a Delaware C is the best vehicle for a number of reasons. But it is estimated that between 1% and 5% of all companies seeking venture financing ever receive it. Setting up every company with the expectation of raising VC money is not a wise choice.
The fact of the matter is that tens of thousands of successful businesses take in investment dollars every year from friends and family, angels, and strategic investors, and the vast majority of these investors could not care less about the entity type. In fact, many of them prefer LLCs because of the pass through tax effects.
What I love about LLCs is their flexibility. An LLC can be structured to look and act like corporations or limited partnerships, all while maintaining favorable tax treatment. Not to mention that they are easy to operate and require less state filing requirements that do corporations.
Now, if you are certain that a corporation is the right fit and you’re going to do business in Texas, then a Texas corporation should be a strong consideration. Yes, Delaware is oftentimes preferred because of its long-standing history of favorable business law and intelligent business courts, but you have to pay Delaware for the privilege of doing business there. This could easily be thousands of dollars in annual filing and professional fees, a heavy sum for a startup. Continuing, the chances that you’ll need one of the nuanced Delaware business laws for your startup at this stage are slim.
Let’s say you do start with a Texas LLC, but then you want to convert your Texas LLC into a Delaware C down the road to take on that venture financing…it’s not a difficult process, especially if you’ve taken care with your company structure up to the point of conversion (please get signatures on all your founder/investment docs and keep a good clean cap table!).
Thus, while a Delaware C is the correct choice for a subset of startups, it’s not the only choice. Please consult with an attorney well versed in startup and entity formation matters before organizing your startup.