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Comment by rajivtiru | Hacker News Reader

    Most angel investors and VCs will also insist that your company be a Delaware C-Corporation for legal reasons

I keep hearing this, but what are these reasons?

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If you invest in an LLC then you will be purchasing membership units. If you have membership units in an LLC, then you have to file a tax form every year (K1) that reports your portion of the earnings or losses from the LLC. The investor will have to pay the taxes on his portion of any profit generated by the LLC, even if the LLC didn't distribute any the profit.

Investors typically have dozens of investments. Filing K1s for all of your investments is a huge amount of work.

The LLC issues the K-1 to the investors, you just attach it like the other 1099ish forms you receive from other sources of income (e.g. 1099-DIV).

As an angel investor, I don't want to deal with that kind of hassle. If the company is losing money, it may want to carry forward the tax losses to offset future profits. If the company is making money, are you also going to distribute cash to your investors to offset the tax liability you just threw onto them? Will you get my K-1 to me well in advance of the April 15 filing deadline so I can plan my taxes, or will you piss me off by getting me a K-1 on Apr 14 and surprising me with a last minute tax liability? If any of your investors are non-US persons, now they have to file US income tax returns. These are the practical reasons why investors hate pass through entities.

Which is entirely fair. I don't think I've ever received a K1 before April 15th, including from the venture funds I invest in.

The reason is that many of their LPs (e.g. pension funds) are non profits, and they can't have taxable income flow up to them or their Unrelated Business Taxable Income will threaten their nonprofit status. VCs are flow-thru entities so any income hitting them from _their_ investments would hit their LPs. Therefore they can only invest in blocking entities.

I agree with this, but out of curiosity, presumably the funds have their own blockers/SPVs below that they could just route their investments through and allow other investors in the startup to receive the flow-through treatment (like we would in hedge/PE). My assumption was that the standardized governance structure of a Corp was also appealing to VCs who prefer it to the possibility of being screwed by an adverse amendment to the LLCA, etc.

yes this is commonly done in PE but for whatever reason it's not done in VC. usually they say it's b/c of compensation via options but i don't actually believe there is a principled reason behind it.

When I did it, I was told in short by legal that "at this point it is a red flag if you don't do it."

The original reasons may have been tax based or precedent based, but at this point it is also because that's the default that VC is used to

Delaware law reliably protects shareholders.

> Most angel investors and VCs will also insist

If they do "insist" on this regardless of circumstances, it would not be ideal to partner with them since they clearly don't know what they are doing. And if you are partnering with someone, don't you want them to know what they are doing?

The list of VCs that insist on a C-Corp is essentially the list of VCs. So sure, you don't need to convert, but you won't ever be able to raise VC money without converting.

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