The C-Corporation: The VC Standard
Why C-Corporations dominate venture-backed startups
What Makes C-Corps Investor-Friendly
1. Stock Structure Flexibility
Can issue multiple classes of stock (Common, Preferred). Can create stock with different voting rights. Can implement liquidation preferences. Can issue stock options through standard plans.
2. Established Legal Framework
Well-understood by investors and attorneys with extensive case law and precedent. Standardized investment documents and clear governance rules.
3. Tax Treatment Investors Expect
No pass-through taxation to investors. No K-1 forms to distribute. No UBTI issues for tax-exempt investors. Potential for QSBS tax benefits (0% capital gains under certain conditions).
4. Exit Compatibility
Can go public (IPO-ready structure). Easy to acquire (buyers understand structure). Clean cap table management. Supports multiple rounds of financing.
5. Delaware Advantage
Most VCs expect Delaware incorporation. Well-developed corporate law with business-friendly court system (Chancery Court). Predictable legal environment.
The C-Corp Trade-offs
Advantages for fundraising:
✓ Investor acceptance (especially VCs)
✓ Multiple stock classes possible
✓ Stock option plans work seamlessly
✓ Clean cap table management
✓ IPO and acquisition compatible
✓ Standardized investment documents
Considerations:
✗ Double taxation (corporate + individual level)
✗ More formalities required
✗ Higher compliance costs
✗ More rigid structure
✗ Corporate-level taxes even without distributions
When C-Corporations Are Commonly Used
Founders typically choose C-Corporations when:
✓ Planning to raise venture capital
✓ Building high-growth, scalable businesses
✓ Considering eventual IPO
✓ Want to offer employee stock options
✓ Need multiple classes of stock
✓ Investors have specifically requested this structure
Common pattern: Many venture-backed startups incorporate as Delaware C-Corporations from day one, or convert to this structure before their first institutional funding round.
For a broader foundation on entity selection, review How to Choose Your Business Structure When You Plan to Raise Money, which explains how investor expectations shape structure decisions from the start.
The LLC Option: When It Works for Fundraising
LLCs can work for certain types of fundraising, but with significant limitations.
When LLCs Are Commonly Used for Fundraising
1. Friends and Family Rounds
- Early-stage capital from personal connections
- Smaller investment amounts
- Investors who trust the founder
- No institutional investors involved
2. Real Estate Ventures
- Property-specific LLCs
- Real estate syndications
- Investors familiar with LLC structure
- Pass-through taxation is advantageous
3. Certain Operating Businesses
- Service businesses with steady cash flow
- Businesses planning modest growth
- When pass-through taxation benefits everyone
- No plans for eventual IPO
4. Family Offices and High-Net-Worth Individuals
- Some sophisticated investors comfortable with LLCs
- Often smaller, more flexible capital sources
- May prefer pass-through taxation
- Willing to deal with K-1 complexity
Why LLCs Are Challenging for Institutional Investment
The problems investors typically face:
1. Tax Complexity
- Every investor receives K-1 tax forms
- Pass-through income creates state tax filing obligations for investors
- UBTI issues for tax-exempt investors (foundations, endowments)
- More complex tax reporting and accounting
2. Less Standardized Documentation
- No established "Series A Preferred Membership Interest" template
- Operating agreements vary widely
- Less predictability for investors
- Higher legal costs to negotiate custom terms
3. Governance Challenges
- Harder to implement traditional VC governance rights
- Board structure less standardized
- Manager vs. member-managed complexity
- Voting rights implementation varies
4. Exit Complications
- Can't do traditional IPO
- Some acquirers prefer corporate targets
- Transfer restrictions may be more complex
- Less familiar to potential buyers
5. Future Fundraising Issues
- Series B, C investors typically expect C-Corps
- Conversion required for later rounds anyway
- Creates complexity mid-growth
- May lose momentum during conversion
The LLC Workaround: Converting Before Institutional Investment
Common pattern observed:
Many founders start with an LLC, then convert to C-Corporation when:
- Approaching first VC round
- Angel investors request conversion
- Planning Series A fundraising
- Preparing for accelerator program
The conversion process typically involves:
✓ Forming a new C-Corporation
✓ Transferring assets from LLC to corporation
✓ Exchanging LLC membership interests for corporate stock
✓ Dissolving the LLC (or merging into corporation)
✓ Addressing tax consequences of conversion
Considerations with conversion:
- Legal and accounting costs (often $5,000-$25,000+)
- Potential tax consequences
- Timing coordination with fundraising
- Documenting the conversion properly
- Updating all contracts and agreements
Many advisors suggest: If you're confident you'll raise institutional capital, incorporating as a C-Corporation from the start often saves time and money compared to converting later.
If you're currently operating as an LLC, our article Single-Member LLC vs. Multi-Member LLC: What's Right for Your Startup? provides critical context on ownership, tax treatment, and compliance before considering conversion.
The S-Corporation: Why It Rarely Works for Fundraising
S-Corporations have strict ownership limitations that make them incompatible with most outside investment.
S-Corp Limitations
Ownership restrictions that affect fundraising:
- Maximum 100 shareholders
- All shareholders must be U.S. citizens or residents
- No corporate or partnership shareholders allowed
- Only one class of stock permitted
- No preferred stock with special rights
Why these matter for fundraising:
✗ Most VCs are structured as partnerships → can't own S-Corp stock
✗ Many angels invest through entities → can't own S-Corp stock
✗ Foreign investors are excluded
✗ Can't give investors preferred stock with liquidation preferences
✗ No stock option plans with different classes
Common pattern: S-Corporations are rarely used for businesses planning external fundraising. They're primarily used for profitable businesses with domestic individual owners who want pass-through taxation without raising outside capital.
Other Structure Considerations
Partnership Structures
General Partnerships (GP) and Limited Partnerships (LP):
- Rarely used for operating startups
- Personal liability concerns with GPs
- More common in real estate and fund structures
- Not typical for technology or product businesses
Series LLCs
Used in specific contexts:
- Real estate holdings (property per series)
- Fund structures
- Multiple product lines with separation
- Not common for traditional startups
- Limited recognition across states
Benefit Corporations and Public Benefit Corporations
Mission-driven structures:
- Allow consideration of stakeholders beyond shareholders
- Growing in popularity for mission-driven companies
- Can be structured as C-Corps
- Some investors comfortable, others hesitant
- Still relatively new (varies by state)
Common pattern: Many social enterprises use Delaware Public Benefit Corporation (PBC) structure while maintaining C-Corp status for investment purposes.
To avoid compliance gaps that raise red flags during due diligence, read What Really Happens When You Form Your Business: Beyond the Paperwork, which outlines the ongoing obligations investors often scrutinize.
Recommended Reading
Learn more about Business Formation for startups.
For a broader foundation on entity selection, review How to Choose Your Business Structure When You Plan to Raise Money, which explains how investor expectations shape structure decisions from the start.
If you’re currently operating as an LLC, our article Single-Member LLC vs. Multi-Member LLC: What’s Right for Your Startup? provides critical context on ownership, tax treatment, and compliance before considering conversion.
To avoid compliance gaps that raise red flags during due diligence, read What Really Happens When You Form Your Business: Beyond the Paperwork, which outlines the ongoing obligations investors often scrutinize.