If you plan to raise venture capital or sell your tech startup one day, it is extremely likely that you should form as a Delaware C corporation. In the last few years I have seen a disturbing trend of people calling themselves “startup lawyers” and steering high growth startups toward LLCs. In most venture-style cases, that advice is misguided.
The short version for why a Delaware C Corporation
VC investors almost always want to invest in a Delaware C corporation. Forming as an LLC and converting later usually creates extra cost, delay, and tax complexity, with little or no upside for a company that is actually pursuing venture funding.
The “LLC first” arguments and why they usually fail
The usual pitch is that a corporation is too complex early, that an LLC is easier, and that you can “clean it up later.” Sometimes the pitch is that you will save a few hundred dollars in filing fees. None of that is a compelling reason to choose the wrong entity for a venture path.
Here are the common “administrative requirements” people cite for corporations:
Hold an annual stockholder meeting and keep basic minutes.
File an annual report and pay franchise taxes.
Respect the roles of the board, stockholders, and officers.
For the annual meeting, it can be held anywhere and in any format. A short call with signed written consents and a simple set of minutes is usually enough. This is not the scary corporate formality people imagine.
You will have annual compliance obligations regardless of entity type. For many startups, the delta between an LLC and a corporation is not the deciding factor people make it out to be, especially when compared to the cost of fixing the wrong structure later.
What is ironic is that when “startups” choose an LLC, the founders often try to run it like a corporation anyway, with managers, officers, and member votes. So you can end up with similar governance complexity plus an entity form that VCs do not want.
Yes, there can be additional costs with being a Delaware corporation, but a few hundred dollars, or even $1,000, should not drive your choice of entity. More importantly, I generally do not think you should incorporate until you are truly all in on the startup.
Double taxation is usually a red herring for startups
A common objection is “double taxation.” A C corporation can be taxed at the corporate level, and then stockholders can be taxed again on dividends. That is the basic idea.
But early stage tech startups generally do not pay dividends. Any cash the company has is usually reinvested into growth. Founder compensation is typically treated as an expense of the business, not a dividend. So in most venture-style scenarios, “double taxation” is not the practical issue people make it out to be.
QSBS can be a real tax benefit for founders and investors
A C corporation can provide another tangible tax benefit: Qualified Small Business Stock (QSBS). C corporation stock, not LLC interests and not S corporation stock, can qualify. If you hold qualifying C corporation stock for five years and meet the other requirements of Section 1202 of the Internal Revenue Code, you may be eligible for a significant reduction in long term capital gains taxes, often between 50% and 100%, subject to caps and other limitations.
Why I care about the Delaware C Corporation
First, I suspect some lawyers recommend LLCs because they are treating “startup” as a synonym for any small business. Sure, a business that does not intend high growth or venture funding can be an LLC. But that is not what most people mean when they say “tech startup.”
And these lawyers often write articles or give presentations with titles like “The Delaware C Corp Myth” to justify an LLC for a venture style company. But the real myth might be that the lawyers recommending LLCs actually work with early stage tech startups seeking actually closing venture capital.
Second, converting later can be expensive, and it can create opportunities for extra legal fees. Conversions are often more work than forming the right entity at the start.
When an LLC can make sense
An LLC can make sense for a profitable small business, a consulting business, many real estate ventures, and some lifestyle businesses that do not plan to raise venture capital. It can also make sense in special cases where pass-through tax treatment is central to the business model. The key is to be honest about which path you are on.
Why Delaware?
1) Predictable case law: Delaware case law is unmatched if an issue comes up. The goal is to reduce uncertainty about how courts will treat common corporate disputes. If your issue does not have strong precedent in a given state, outcomes can become harder to predict.
2) VC familiarity and standard documents: VC lawyers and VC firms are already familiar with Delaware law and requirements. Many venture documents assume Delaware as the governing law, and it becomes costly to customize a full venture document set for many different states across a portfolio.
If you want venture funding, default to a Delaware C corporation.
If you want QSBS potential, you need qualifying C corporation stock.
If you are building a non venture small business, an LLC may be fine.
If you are unsure, decide based on your intended financing path, not based on minor filing fee differences.
So do your tech startup a favor: if you are an early stage technology company that plans to raise venture capital, incorporate as a Delaware C corporation at the start. It is the structure investors expect, it keeps financings smoother, and it reduces the odds that you have to pay to unwind a mismatched entity later.
Ryan RobertsStartup Lawyer
Ryan Roberts is a startup lawyer with more than two decades of experience advising on venture financings and M&A transactions totaling more than $1 billion. He is the author of the Amazon bestselling startup law book Acceleration.
