The Timing Question: When to Choose Your Structure

Starting with End in Mind

Founders commonly consider:

Red Flags for Investors

Structures that commonly raise concerns:

• Messy cap tables - Too many small investors, unclear ownership
• Unusual structures - Custom entities that don't fit standard models
• Poor documentation - Missing or inadequate operating agreements/bylaws
• Vesting issues - Founders with unvested equity
• Complex ownership - Circular ownership, trusts, foreign entities
• S-Corporation with plans to raise VC - Structurally incompatible

State Selection: Delaware vs. Home State

The Delaware Default for VC-Backed Companies

Why Delaware C-Corporations dominate:

Established corporate law:

• Extensive case law and precedent
• Predictable legal environment
• Business-friendly statutes
• Specialized Court of Chancery

Investor expectations:

• VCs typically expect Delaware incorporation
• Standardized investment documents assume Delaware
• Attorneys familiar with Delaware law
• Easier due diligence process

Flexibility:

• Modern corporate statutes
• Supportive of various governance structures
• Allows indemnification provisions
• Recognizes common VC terms

Costs:

• Annual franchise tax (~$400 minimum for typical startup)
• Registered agent fees (~$100-300/year)
• Must also register in states where operating (foreign qualification)

Home State Incorporation

When founders commonly use home state:

• Not raising venture capital
• Bootstrapping or modest growth plans
• Investors don't require Delaware
• Want to minimize costs
• Simpler compliance desired

Considerations:

• Lower annual fees in many states
• No foreign registration in home state
• Local attorneys may be more familiar
• But may need to convert to Delaware for VC funding

Common pattern: Bootstrapped businesses often start in their home state. VC-track businesses typically choose Delaware from the start.

Equity Compensation and Structure

Stock Options

C-Corporations allow traditional employee stock options:

• Incentive Stock Options (ISOs)
• Non-Qualified Stock Options (NSOs)
• Well-established 409A valuation process
• Standard vesting schedules
• Familiar to employees and investors

LLCs have limitations:

• No traditional stock options
• Can grant "profits interests" (more complex)
• Less familiar to employees
• Harder to explain value
• More complex tax treatment

Common pattern: Companies planning significant hiring with equity compensation typically use C-Corporation structure for simpler option administration.

Founder Equity and Vesting

Regardless of structure, founders commonly implement:

• 4-year vesting schedules
• 1-year cliff
• Accelerated vesting provisions (single or double-trigger)
• Reverse vesting or restricted stock

Investors typically require:

• All founder stock subject to vesting
• Buy-back rights for unvested shares
• Clear documentation of vesting terms
• Consistency across founders

International Considerations

Foreign Founders

U.S. business structures for non-U.S. founders:

• C-Corporations work for foreign founders
• Can own stock in C-Corp regardless of citizenship
• S-Corporations prohibited for non-U.S. residents
• Tax implications for foreign owners vary

Common pattern: International founders building in U.S. market typically form Delaware C-Corporation.

Foreign Investors

International investors typically prefer:

• C-Corporations (avoid partnership K-1s)
• Clear documentation and governance
• Structure they can explain to their stakeholders
• Avoid U.S. tax filing obligations from pass-through entities

The Conversion Process: LLC to C-Corp

Since this is such a common path, here's what typically happens:

When Conversion Commonly Occurs

• Before approaching VCs for Series A
• When angels require it as condition of investment
• Upon acceptance to VC-backed accelerator
• When counsel advises it for upcoming fundraise

Steps Typically Involved

1. Formation of new corporation

• File Certificate of Incorporation (usually Delaware)
• Adopt bylaws
• Issue initial stock to founders

2. Asset transfer

• Transfer business assets from LLC to corporation
• Assign contracts and agreements
• Transfer IP rights
• Update vendor/customer relationships

3. Exchange of interests

• LLC membership interests exchanged for corporate stock
• Implement vesting schedules
• Document 83(b) elections if needed

4. Tax considerations

• Structure as tax-free reorganization if possible
• File appropriate tax forms
• Address any tax consequences

5. Cleanup

• Dissolve or merge LLC
• Update all legal documents
• Notify stakeholders
• File necessary state documents

Special Situations

Convertible Notes and SAFEs

Bridge financing instruments:

• Allow raising money before finalizing structure
• Convert to equity in future priced round
• Give time to complete entity conversion
• Popular for pre-seed and seed funding

Common pattern: Founders sometimes raise initial capital on convertible notes/SAFEs while still LLC, then convert to C-Corp before the notes convert to equity.

Revenue-Based Businesses

For businesses with revenue but modest venture ambitions:

• LLC structure may work fine
• Pass-through taxation advantageous
• Investors comfortable with profit distributions
• May never need VC-style fundraising

Acquisition as Exit Strategy

If acquisition (not IPO) is the goal:

• C-Corp still often preferred
• Some acquirers comfortable with LLCs
• Depends on acquirer's structure and preferences
• Asset purchase vs. stock purchase considerations

Common Mistakes to Avoid

Mistake 1: Choosing Structure Based Only on Current Needs

Some founders optimize for today without considering tomorrow. Structure decision should account for likely fundraising path.

Mistake 2: Waiting Too Long to Convert

Converting mid-fundraise creates delays and complications. Many founders convert before actively fundraising.

Mistake 3: Not Implementing Founder Vesting

Regardless of structure, founder vesting is typically expected by investors and protects against co-founder departures.

Mistake 4: Choosing S-Corp Before Understanding Limitations

S-Corp restrictions make it incompatible with most outside investment, requiring costly conversion later.

Mistake 5: Creating Overly Complex Structures

Custom or unusual structures create investor hesitation and higher due diligence costs.

Mistake 6: Not Consulting with Professionals

Entity selection for fundraising involves legal, tax, and securities law considerations that benefit from professional guidance.

Decision Framework for Fundraising-Oriented Businesses

Consider these factors:

Question 1: What type of capital are you raising?

Question 2: What's your growth trajectory?

High-growth, venture-scale:

• C-Corporation standard
• Plan for multiple funding rounds
• IPO or major acquisition exit path

Modest, sustainable growth:

• LLC may work well
• Simpler structure, pass-through taxation
• Less likely to need institutional capital

Question 3: What's your exit strategy?

IPO potential:

• C-Corporation required
• Start with proper structure

Acquisition expected:

• C-Corporation preferred by most acquirers
• Some acquirers comfortable with LLC

Long-term hold:

• LLC may offer advantages
• Pass-through taxation beneficial
• Less need for multiple stock classes

Question 4: Where are you and your investors located?

U.S. founders and investors:

• Full flexibility on structure

International founders or investors:

• C-Corporation typically simplifies matters
• Avoids certain tax complications
• More familiar structure globally

Question 5: What do your advisors recommend?

Attorney guidance:

• Entity formation attorney can assess specific situation
• Securities attorney if raising capital
• State-specific considerations

Tax advisor input:

• CPA familiar with startup taxation
• Consider current and future tax implications
• Optimize for likely scenarios

Mentor feedback:

• Founders who've raised capital successfully
• Industry-specific norms
• Practical experiences

The Bottom Line

Business structure for fundraising isn't one-size-fits-all, but clear patterns emerge:

Key principles many successful founders follow:

• Choose structure with fundraising goals in mind
• Don't optimize only for current situation
• Convert early if institutional capital is likely
• Implement proper vesting and documentation regardless of structure
• Work with experienced professionals on entity selection
• Understand investor expectations in your industry
• Plan for complexity and growth from the start

Most importantly: Entity selection for fundraising involves legal, tax, and securities considerations that vary by circumstance. Consultation with qualified attorneys and tax advisors is strongly recommended before making this decision.