Why Investors Prefer to Invest in C Corporations

If you are in the early stages of founding a new startup, it is important to discuss your entity structure with a startup attorney in relation to your plans for raising capital. In the very early stages of a startup, it may be the case that you do not yet have specific plans for raising capital or funding your business, though you likely have some ideas about how you want to fund the startup. You should be aware that the structure of your business may ultimately have an effect on the type of funding that your startup can obtain, especially when it comes to equity financing from venture capital (VC).

Generally speaking, as for equity financing and obtaining this type of funding from investors, you may want to consider forming a C corporation, or C-corp, from the outset. Our startup attorneys can provide you with more information about why many investors prefer to invest in C corporations, and we can begin working with you today to ensure that your startup is structured appropriately based on your plans and business needs in the future.

C Corporation Benefits for Many Investors

For many investors, and venture capital firms in particular, there is only interest investing in (i.e., providing equity financing for) startups that are structured as C corporations. There are several reasons for this.

First, there is a tax reason: with any other type of entity structure, there will be “pass-through taxes,” which means the shareholders will be paying individual federal income taxes on returns, and this is not something that a VC wants. Second, VC firms and often angel investors, too, want preferred stock, which is only something that C-corps can offer.

Third, there’s qualified small business stock (QSBS). Under Section 1202 of the Internal Revenue Code, founders and investors who hold qualifying C-corp stock for at least five years may be able to exclude up to $15 million of gain (or 10x their basis, if greater) from federal income tax when they sell. For stock issued after July 4, 2025, a partial exclusion is available after as little as three years. LLC units don’t qualify. Neither does S-corp stock. On a successful exit, QSBS can be the single most valuable tax benefit on the table, for investors and founders alike.

Fourth, international investors. An LLC taxed as a partnership passes its income through to its members, including foreign ones. If the LLC is running a U.S. business, a non-U.S. investor can get pulled into the U.S. tax system as a result: filing U.S. returns, withholding on their share of the income, and potentially U.S. tax when they sell their interest. Most foreign investors (and many U.S. funds with foreign limited partners) won’t sign up for that. Owning stock in a C-corp keeps them out of it.

Fifth, a corporation comes with a meaningful layer of statutory protection and process. Corporate statutes, Delaware’s in particular, dictate how shares are issued, how directors and stockholders act and vote, what fiduciary duties directors owe, and what rights stockholders have to information. Decades of case law fill in the gaps. An LLC, by contrast, is largely a creature of contract. The operating agreement can modify or even eliminate fiduciary duties, and no two look quite the same. With a C-corp, investors know what they’re getting. With an LLC, they have to read (and pay a lawyer to read) the fine print.

There are also other considerations to keep in mind, but these are key issues that you should think about when you are forming a startup and deciding how to structure the entity. It is also crucial to know that the benefits described above only apply to C-corps and not to S corporations or S-corps (in addition to LLCs and partnerships).

Do You Need to Convert to a C Corporation?

If your startup is already structured as an LLC for example, you may be wondering if you need to convert to a C-corp. For some startups, having an LLC entity structure works, especially if you are planning to self-fund your business or seek debt financing.

Angel investors also may decide to invest in an LLC, so you may be able to obtain equity financing from an angel investor even if your startup is not structured as a C-corp. An experienced startup attorney can advise you.

Structure Your Startup for the Money You Plan to Raise

Whether you have questions about entity structure and formation for your startup, or you want to find out more about entity conversion, one of the startup attorneys at Triumph Law can assist you. Contact our firm today for more information about the services we provide.

Source:

taxfoundation.org/taxedu/glossary/c-corporation-c-corp/