What is best for a startup company: S-, C-Corp or LLC?

If you wish to have a VC invest in your business, C-Corp is the way to go. While Mr. O’Brien’s answer is correct as far as it goes, there are a few more things I’d like to point out. The reason that VCs prefer C Corps to S Corps and LLCs is twofold. S-Corps cannot have shareholders who are corporations, partnerships, or non-US persons. Most, if not all, VC funds are organized as partnerships or partnership-like organizations. With regard to VCs investing in LLCs, the problem lies in tax law. While a partnership may own interests in another LLC, if the VC fund has investors who are tax-exempt or foreign, investing in an LLC can have serious tax consequences. The VC fund’s partnership agreement may limit its ability to make investments that generate unrelated business taxable income for the tax-exempt investors or income that’s effectively connected with a U.S. trade or business for the foreign investors. Both of these types of income will knock out the investors tax-exempt status. The VC may also prefer investments in C corporations to avoid pass-through tax reporting. If you’d like any further guidance with this issue, please do not hesitate to contact me.

A limited liability company is owned by members. These members can either jointly run the company, appoint a committee to run the company or can appoint a manager to run the company. Depending on state law, there can be relationships of various complexity between managers. An LLC can be taxed as a pass-through entity, this means that earnings (or losses) of the LLC pass directly from the LLC to the corporation without a separate layer of taxation.

A corporation is a business entity that is owned by shareholders. The shareholders elect a board of directors and the directors hire officers that run the day to day business. This precise arrangement varies by business and, to a certain extent, state law. The earnings of the corporation are taxed and then if the corporation pays those earnings out as dividends then they are taxed again. Sometimes this is called double taxation.

Either an LLC or a corporation can elect to be taxed under Subchapter S of the Internal Revenue Code (26 USC 1361 et seq.). To be eligible for this election, the number and kind of shareholders are limited and those limitations may disturb your venture capital firm. If Subchapter S election is made, each officer is paid a wage and a distribution. The former is subjected to employment taxes and the latter is generally not.

For the sake of brevity, I have grossly over simplified the features of these entities. Your individual situation probably requires a more detailed analysis with a more comprehensive factual profile of your situation. If you reach out to me, I would be happy to advise your firm if you are in a state in which I am barred.