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Most angel investors and VCs will also insist that your company be a Delaware C-Corporation for legal reasons I keep hearing this, but what are these reasons?

rsweeney21 10y ago
If you invest in an LLC then you will be purchasing membership units. If you have membership units in an LLC, then you have to file a tax form every year (K1) that reports your portion of the earnings or losses from the LLC. The investor will have to pay the taxes on his portion of any profit generated by the LLC, even if the LLC didn't distribute any the profit. Investors typically have dozens of investments. Filing K1s for all of your investments is a huge amount of work.
- epc 10y ago
  The LLC issues the K-1 to the investors, you just attach it like the other 1099ish forms you receive from other sources of income (e.g. 1099-DIV).
  - chrismaeda 10y ago
    As an angel investor, I don't want to deal with that kind of hassle. If the company is losing money, it may want to carry forward the tax losses to offset future profits. If the company is making money, are you also going to distribute cash to your investors to offset the tax liability you just threw onto them? Will you get my K-1 to me well in advance of the April 15 filing deadline so I can plan my taxes, or will you piss me off by getting me a K-1 on Apr 14 and surprising me with a last minute tax liability? If any of your investors are non-US persons, now they have to file US income tax returns. These are the practical reasons why investors hate pass through entities.
    - epc 10y ago
      Which is entirely fair. I don't think I've ever received a K1 before April 15th, including from the venture funds I invest in.
droithomme 10y ago
> Most angel investors and VCs will also insist If they do "insist" on this regardless of circumstances, it would not be ideal to partner with them since they clearly don't know what they are doing. And if you are partnering with someone, don't you want them to know what they are doing?
- mikeyouse 10y ago
  The list of VCs that insist on a C-Corp is essentially the list of VCs. So sure, you don't need to convert, but you won't ever be able to raise VC money without converting.
  - droithomme 10y ago
    Your statement is a complete lie mikeyouse, but thank you for playing.
    - mikeyouse 10y ago
      I'll couch it more, every single VC I've ever taken money from, talked to about taking money, or read about their criteria for taking money requires a C-Corp. After a short search, I've found precisely one company who remained a LLC while taking VC money (Seedinvest who raised from a number of small seed-stage VCs). Are there others I'm missing?
    - dang 10y ago
      We ban accounts that post uncivil, unsubstantive comments like this, so please don't do that. If you have a substantive point to make, make it thoughtfully; otherwise please don't post until you do. https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newswelcome.html https://news.ycombinator.com/newswelcome.html
      - droithomme 10y ago
        I find my comments, made over many years, to be civil and substantive. I find you dang to be a disruptive propaganda artist. Ban me if you wish as part of your viewpoint censorship efforts, I don't mind at all. I stand 100% behind all I said, and I denounce you dang as an enemy of democracy and truth. Only you can live with the hate in your heart, your dishonesty, your censorship, and your war against truth and reality. You make your bed of dishonesty, corruption, censorship and manipulation, and you lay in it. It is your choice to do so, and in so doing to harm humanity.
27182818284 10y ago
When I did it, I was told in short by legal that "at this point it is a red flag if you don't do it." The original reasons may have been tax based or precedent based, but at this point it is also because that's the default that VC is used to
tvladeck 10y ago
The reason is that many of their LPs (e.g. pension funds) are non profits, and they can't have taxable income flow up to them or their Unrelated Business Taxable Income will threaten their nonprofit status. VCs are flow-thru entities so any income hitting them from _their_ investments would hit their LPs. Therefore they can only invest in blocking entities.
- piker 10y ago
  I agree with this, but out of curiosity, presumably the funds have their own blockers/SPVs below that they could just route their investments through and allow other investors in the startup to receive the flow-through treatment (like we would in hedge/PE). My assumption was that the standardized governance structure of a Corp was also appealing to VCs who prefer it to the possibility of being screwed by an adverse amendment to the LLCA, etc.
  - tvladeck 10y ago
    yes this is commonly done in PE but for whatever reason it's not done in VC. usually they say it's b/c of compensation via options but i don't actually believe there is a principled reason behind it.
Digory 10y ago
Delaware law reliably protects shareholders.

rsweeney21 10y ago

If you invest in an LLC then you will be purchasing membership units. If you have membership units in an LLC, then you have to file a tax form every year (K1) that reports your portion of the earnings or losses from the LLC. The investor will have to pay the taxes on his portion of any profit generated by the LLC, even if the LLC didn't distribute any the profit. Investors typically have dozens of investments. Filing K1s for all of your investments is a huge amount of work.

epc 10y ago
The LLC issues the K-1 to the investors, you just attach it like the other 1099ish forms you receive from other sources of income (e.g. 1099-DIV).
- chrismaeda 10y ago
  As an angel investor, I don't want to deal with that kind of hassle. If the company is losing money, it may want to carry forward the tax losses to offset future profits. If the company is making money, are you also going to distribute cash to your investors to offset the tax liability you just threw onto them? Will you get my K-1 to me well in advance of the April 15 filing deadline so I can plan my taxes, or will you piss me off by getting me a K-1 on Apr 14 and surprising me with a last minute tax liability? If any of your investors are non-US persons, now they have to file US income tax returns. These are the practical reasons why investors hate pass through entities.
  - epc 10y ago
    Which is entirely fair. I don't think I've ever received a K1 before April 15th, including from the venture funds I invest in.

droithomme 10y ago

> Most angel investors and VCs will also insist If they do "insist" on this regardless of circumstances, it would not be ideal to partner with them since they clearly don't know what they are doing. And if you are partnering with someone, don't you want them to know what they are doing?

mikeyouse 10y ago
The list of VCs that insist on a C-Corp is essentially the list of VCs. So sure, you don't need to convert, but you won't ever be able to raise VC money without converting.
- droithomme 10y ago
  Your statement is a complete lie mikeyouse, but thank you for playing.
  - mikeyouse 10y ago
    I'll couch it more, every single VC I've ever taken money from, talked to about taking money, or read about their criteria for taking money requires a C-Corp. After a short search, I've found precisely one company who remained a LLC while taking VC money (Seedinvest who raised from a number of small seed-stage VCs). Are there others I'm missing?
  - dang 10y ago
    We ban accounts that post uncivil, unsubstantive comments like this, so please don't do that. If you have a substantive point to make, make it thoughtfully; otherwise please don't post until you do. https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newswelcome.html https://news.ycombinator.com/newswelcome.html
    - droithomme 10y ago
      I find my comments, made over many years, to be civil and substantive. I find you dang to be a disruptive propaganda artist. Ban me if you wish as part of your viewpoint censorship efforts, I don't mind at all. I stand 100% behind all I said, and I denounce you dang as an enemy of democracy and truth. Only you can live with the hate in your heart, your dishonesty, your censorship, and your war against truth and reality. You make your bed of dishonesty, corruption, censorship and manipulation, and you lay in it. It is your choice to do so, and in so doing to harm humanity.

27182818284 10y ago

When I did it, I was told in short by legal that "at this point it is a red flag if you don't do it." The original reasons may have been tax based or precedent based, but at this point it is also because that's the default that VC is used to

tvladeck 10y ago

The reason is that many of their LPs (e.g. pension funds) are non profits, and they can't have taxable income flow up to them or their Unrelated Business Taxable Income will threaten their nonprofit status. VCs are flow-thru entities so any income hitting them from _their_ investments would hit their LPs. Therefore they can only invest in blocking entities.

piker 10y ago
I agree with this, but out of curiosity, presumably the funds have their own blockers/SPVs below that they could just route their investments through and allow other investors in the startup to receive the flow-through treatment (like we would in hedge/PE). My assumption was that the standardized governance structure of a Corp was also appealing to VCs who prefer it to the possibility of being screwed by an adverse amendment to the LLCA, etc.
- tvladeck 10y ago
  yes this is commonly done in PE but for whatever reason it's not done in VC. usually they say it's b/c of compensation via options but i don't actually believe there is a principled reason behind it.

Digory 10y ago

Delaware law reliably protects shareholders.