Founders have been known to set up LLCs at the earliest stages of their ventures for obvious reasons, including:
- LLCs tend to have flexible management structures and are often easier to maintain. Unlike corporations, LLCs are not required to comply with a formal management structure; and
- LLCs tend to have flexible tax regimes. An LLC can elect to be taxed as a sole proprietor, partnership, or corporation. Using default tax classifications, profits are taxed personally at the member level, not at the LLC level.
For more information, check out our article on What’s the Difference between a C Corp, S Corp, and LLC?
Potential Problems with Forming an LLC for your Startup
LLCs have some notable limitations and are not the best choice for accelerated growth startups for many reasons, including (but not limited to) the following:
- The equity compensation process for employees is not as straightforward in LLCs and standard incentive stock options employed by C corporations are typically not available. Moreover, if you have any inclination to pursue outside funding, you’ll be better off steering clear of creative, complex equity structures that fall outside the C corporation norm so that you avoid unnecessary scrutiny from potential investors and acquirers.
- Investors may be wary of the LLC structure and prefer the traditional corporate structure of a C corporation. This can make raising capital very difficult for members of an LLC.
Can’t I just convert my LLC to a C Corp later on?
Not so fast! You may run into some problems if you try to convert your LLC into a C corporation at a later date:
- Not all states permit the conversion from an LLC to a C corporation;
- A conversion from an LLC to a C corporation may have surprising tax implications and you should make sure you hire an experienced accountant to advise you. If your IP development, employee acquisition, and customer engagement are well underway, the conversion costs can be costly and time consuming.
- Even if a state permits the conversion to take place, make sure you hire an experienced startup lawyer to lead this charge on your behalf. Remember that potential investors and acquirers will run you through a thorough due diligence process, which will expose any corporate vulnerabilities and put the transaction at risk. Do things the right way to start!