Every entity is not a Delaware C Corporation
I hear lots of folks saying "Delaware C Corp" in answer to the form of entity appropriate for investment. Of course I am not a tax professional or a lawyer, so I do not give advice in this arena without that warning and telling you to check with yours before making any decisions.
A little knowledge is a dangerous thing. You are warned, I am not the greatest expert in these areas. But in my experience, there are reasons people end up investing in entities that are not Delaware C Corporations. Here are some of them:
It doesn't come that way: Sometimes the companies that show up are not DE-C-Corp entities. They may be in another state, another country, or S-Corps or LLCs. In many cases, they are very early or have been running for a long time. It will take them time and money and paperwork to change, and cost them more to operate. Most of them tell me that if I spring for the first $25K for conversion, they will convert, but then the money won't be used to forward the entity in any other way. Would you rather spend your money on the conversion or the business? Of course at some point, things change, but in the early stages...
We can always change it later: From an LLC or an S-Corp, you can create a C-Corp fairly easily. But from a C-Corp, creating an LLC or an S-Corp on a cash basis may be far more expensive and difficult. So if you don't know what you need today, why not spend less money, take less time, have less paperwork, and go with an LLC? Why do accrual accounting if you don't have to? A cash basis is perfectly fine for many entities and may make things far simpler in many ways.
I end up paying more taxes that way: As a C-Corp, you pay corporate taxes on profits and when you pay yourself, you pay income taxes on the pay, and the company pays payroll taxes on your pay. That's a triple tax hit (sort of). You may also have to do this in more than one state. The accounting complexity is beyond the normal business person to run.
It's too complicated: The paperwork for a C-Corp in a different state can be pretty substantial, and normally requires several tax forms, different (and more) paperwork, and higher costs. Unless and until you RE ready for the complication, why spend your time on that instead of other things, like building the business?
There are likely many other reasons, but you get the idea. And of course there are lots of answers from investors about why you should not do these things (LLC / S-Corp / other).
Taxes get complicated
I am currently an investor in quite a few companies that are not DE C-Corps. I get Schedule K-1 paperwork from a bunch of them, and not all what you would call on time. It's July, so you figure it would be done, but I just got one last week, and several companies I have not gotten paperwork from yet. My accountant will be finishing my last year taxes soon, I hope... but really, it shouldn't take this long.
Another issue is that all these K-1 things produce more or less tax. The one I just got produced a loss of $35. That is, I will have to pay taxes on $35 less than I otherwise would have to. Of course it may cost me more than that to update my taxes to reflect this change, and I have gotten some for less than $10. Some may even produce a profit, but then I have to pay taxes even if I never got the draw from the company. And if each is in a different state or country, I end up having to do paperwork for another state. The last one was from Rhode Island. These are examples of why many investors want as few states involved and only C corporations.
Of course taxes and all the other things associated with a C corporation are a burden for a small startup barely getting going. So I can hardly blame them for doing it their way. And I run only LLCs and S corporations on a cash basis these days because it reduces my paperwork and retains the liability protection, is less expensive to operate, and is simpler from a tax standpoint.
Don't change it before coming to me for help
The worst thing that happens is when startups decide that, before they engage in my advisory services, they will change the form of their entity.
First off, don't do it on my behalf. It is you that will have the real problems, more so than me. My taxes are already so complicated that one more state tax form won't likely make a difference, and it's getting to the point where I will end up filing in every state regardless.
Second item - when you make the change, you would not want to have to do it again once we find out that what you wanted / needed is not what you had or changed to. I am not a tax professional, but I do know that different investment processes and stock classes and ownership requirements often apply after diligence is mostly done than before.
Third item - there are three outcomes from our internal diligence process. (1) The company doesn't get through it and decides not to proceed in that manner/direction; (2) The company decides it would do better if it did not go for outside equity investment often because the owners will end up with more by growing more slowly and not selling shares, warrants, or convertible notes; (3) The company decides it does want to take on equity (or convertible debt) and has to structure the stock for different classes, often different than previously anticipated.
In any case, you should see by now that the decision is often better mad after you figure out the rest of the internal diligence process and not as a precondition of starting the process.
I don't want to beat a dead horse here. Whatever you have now, if you are coming to A2E for advice about what to do next, don't make changes just before you start working with us. It will likely cost you more, have to be changed again, and take more time to get through the diligence process.
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