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The reason most attorneys advise Delaware is that the precedents are strongest there. Furthermore, it makes long-term legal costs lower because most corporate
by weeblyrocks 19y ago
The reason most attorneys advise Delaware is that the precedents are strongest there. Furthermore, it makes long-term legal costs lower because most corporate lawyers are familiar with Delaware's nuances.
All corporations are C by default. You have to file a special from with the IRS to become an S Corporation. S Corporations are flow-through entities which are not taxed at the corporate level. The reason VCs require you to be a C Corporation is two-fold:
1. VCs like to have unilateral rights and terms to give them downside protection such as liquidity preference and preferential stock classes such as Preferred Shares. S Corporations are simpler entities which only allow a maximum of 40 shareholders - as your company grows and you give stock grants or options, this won't work. LLCs only allow 75 shareholders.
2. VCs will claim that a C Corp structure gives you more flexibility. This is marginally true, but LLCs give you the same flexibility with slightly higher administrative cost but you can maintain the flow-through status which is advantageous.
The real reason is they want preferred shares and special rights. Stay an LLC or S Corporation if you don't need institutional investors. Angels are happy to invest in well structured LLCs or standard subchapter S Corporations.
- drusenko 19y agowho are you? :)
- weeblyrocks 19y agoSomeone.
- mcu 19y agoWhoever you are, thank you. Could you suggest any good books on the VC process? I'd like to be prepared if we decide to go that route.
- weeblyrocks 19y agoYou're most welcome. The best entrepreneur's legal guide is called "Entrepreneur's Guide to Business Law" published by Thompson / West Law written by Bagley and Dauchy. I bought it when I was doing my first start-up and I'm sure they have an updated version. I just found one at Amazon: http://www.amazon.com/Entrepreneurs-Guide-Business-Law/dp/0314223169 http://www.amazon.com/Entrepreneurs-Guide-Business-Law/dp/03... In general, I think too many young entrepreneurs give up too much equity too quickly because they fall for the "oh we're making the pie bigger so giving us a huge percentage is fine" fallacy. There are so many things to take into account when taking VC money. Too many VC firms replace young CEOs quickly at which point the founders get heavily diluted. Also be careful of VCs that try to reserve too large of a pool for management they want to recruit. Management team members recruited by your VC work for the VC, not for you, the CEO. When push comes to shove, they will side with the VC because they know the VC will find them another job if your start-up goes bust. The golden rule of VCs is this: He who has the gold makes the rule.
- weeblyrocks 19y agoOne more reason to stay a subchapter S Corporation if you don't need to raise VC money: - There is a special election you can make when you sell the company that allows you to sell the assets instead of the equity which is something you can get the acquirer to pay more for because they can get a stepped up basis at market value and then depreciate it to create tax savings. I don't remember the exact research, but I believe subchapter S corporations that undertake the election sell for 10% more than companies that cannot or do not take the election with all other things being equal.
- epi0Bauqu 19y agoI believe LLCs also have this property (or something similar where a stepped-up basis can be achieved for the buyer).
- epi0Bauqu 19y agoHere's another: http://www.amazon.com/Term-Sheets-Valuations-Intricacies-Venture/dp/1587620685 http://www.amazon.com/Term-Sheets-Valuations-Intricacies-Ven...