Are you considering VC funding? Want to apply for a business loan? Did you know that your legal business structure impacts the type of capital and financing you can access for your business?
Choosing which kind of business structure is right for your business will depend on what kind of financing you want to seek.
When applying for a business loan
Many small businesses look to get a business loan from a traditional lender or commercial bank. If you decide to pursue this route, creating a legal entity is the first step to building your business credit.
A sole proprietor can’t apply for a business loan or business credit; sole proprietors can only get personal loans, whether they need that money to hire a software developer or buy a new car for personal use. In order to receive a business loan or investment, you need to separate the business from your personal finances and this means setting up a legal business entity. In this case, you can choose among a corporation (C Corporation or S Corporation) or an LLC.
When you’re seeking Venture Capital (VC) funding
The C Corporation is the best option for anyone seeking funding from an angel investor or venture capitalist. Limited Liability Companies (LLC) and Limited Liability Partnerships (LLPs) are not favored because of the variation in rules across states, as well as the fact that these entities do not support the legal structure of shareholders, a board of directors, and officers – all critical components of VC investment.
Some VCs actually have specific conditions written that prevent them from investing in any other entity besides a C Corporation.
However, for the small business, the C Corporation can be overkill. The amount of paperwork involved with the C Corp is significant. Meeting minutes must be kept; addenda must be filed for any change. And then there’s something known as ‘double taxation’. Unlike the LLC or S Corporation, the C Corporation is taxed separately and must file its own taxes. In some cases, the owners of a C Corporation can end up with a pretty hefty tax burden as they need to pay taxes on both the Corporation’s profits, as well as whatever income or dividends they personally collected.
For this reason, a small business that is considering VC funding down the road might choose to take two different avenues.
Create a C Corp and elect for S Corporation tax treatment
If you have less than 35 shareholders, you can elect to be an S Corporation for tax purposes. This conversion is one of the easiest changes to make ¾ it can be done with a single tax form. You must file IRS election form 2553 within a short timeframe after incorporating, so be sure to check with the IRS regarding the filing and deadlines. Our specialists at CorpNet will be happy to help you navigate the process as well. And if you need to expand beyond 35 shareholders in the future, you can change your tax status back to a C Corporation to do so.
It’s important to note that the IRS places certain restrictions on who can form S Corporations. For example, all shareholders in an S Corp must be individuals (not LLCs or partnerships) and legal residents of the United States.
Create an LLC then convert to a C Corp later
This option should be pursued only if you truly aren’t sure you’ll ever look for VC funding, or if your plans are many years down the road. The LLC gives you a low-frills way to protect your personal assets; there’s far less paperwork and administrative formalities involved with an LLC than a C or S Corp.
The specific steps for converting from an LLC to a corporation will depend on the corporate laws in whatever state your LLC is registered. In many cases, you’ll be creating a new C Corp and then making the original LLC a subsidiary of the new C Corp. This is a relatively standard process, and CorpNet can help you every step of the way.
Here at CorpNet, we can walk you through each of these steps to get your business off the ground in whatever way makes the most sense for your funding plans.
Call us at 888-449-2638 to get started. We work in all 50 states and our services are backed by a 100% satisfaction guarantee. We make everything easy for you so that you can focus on what you do best – running your business!