What type of entity should I create?

TLDR: Most start-ups choose to form Delaware C corporations.

The most common entity types among start-up companies are: (i) C corporations (C corps); (ii) Limited Liability Companies (LLCs); and (iii) S corporations (S corps), with the vast majority of start-ups choosing to form C corps. These entity types differ significantly in taxation, ownership, structure, governance, fundraising, and employee compensation.

In general, in order to raise traditional venture financing, you will need to form a C corp, which allows you to issue preferred stock. Venture investors are familiar and comfortable with the C corp structure, and that structure also gives the company the ability to grant options and other equity incentives to its service providers. These features are important if you are aiming to reduce friction in both bringing in investment and attracting talent, as they have become the standard in Silicon Valley.

LLCs are much less common because LLCs are more bespoke and consequently more costly to form and maintain. In addition, venture funds typically refuse (and in some cases, may not be permitted) to invest in LLCs, generally for tax reasons, and converting an LLC to a C corp prior to accepting financing can be costly. However, LLCs do make sense in certain circumstances (e.g., where traditional venture financing is unnecessary) because of the flexibility in structure and the “flow-through” tax treatment, which generally subjects LLC members to one level of taxation on any income of the LLC and may allow LLC members to use taxable losses at the entity level to offset other income on their individual tax returns, subject to applicable limitations. On the other hand, C corps are subject to “double taxation”—in other words, any income is taxed once at the entity level and a second time at the stockholder level when dividends or other distributions are paid to stockholders. Equity incentive awards in LLCs may also be more tax-efficient for the recipient (though also more complicated). 

If you want to take advantage of “flow-through” tax treatment prior to taking in venture financing, you can also consider initially electing to form an S corp, so long as there are no entity or non-U.S. citizen/resident stockholders in the company and certain other requirements are met. Though S corps may only issue one class of stock (e.g., common stock), S corps are nearly identical in structure to C corps, and the S corp election automatically terminates at the time of a preferred stock financing. However, the requirements to maintain an S corp election are very stringent and it can be difficult to avoid an inadvertent termination of the S corp election. In addition, shares issued by an S corp are generally not eligible for “qualified small business stock” (QSBS) benefits, even if the S corp terminates its election and becomes a C corp.

---

The answer provided is for general informational purposes only, does not constitute legal advice, and may be considered attorney advertising in some jurisdictions. Prior results do not guarantee a similar outcome. For more information, see the site’s Terms of Use.