It has often been said that investors prefer corporations over LLCs. Although LLCs are easier to set up, the main reason that investors tend to prefer corporations comes down to two important factors:
1. Fewer tax issues
An LLC is taxed as a partnership. LLCs have taxes flow through the members and all members are taxed on their share of profit. In an LLC, owners receive profits in whatever way the money was introduced to the company which could be royalties, dividends, and ordinary income, which result in higher administrative costs of owning a portion of an LLC.
Passive investors and even non-US investors can become subject to income tax if the business actively trades or conducts business in other states. Also, venture capital funds have tax-exempt partners which make it difficult to receive active trade or business income due to tax-exempt status and therefore difficult to invest in.
Investors prefer not to complicate their personal tax situations as they can be taxed on the entity’s income many years after — when cash is not distributed to them personally. Instead, investors are looking for a payout at the end of a certain period of time. Shark Tank tends to highlight this point very well.
2. Issues with Ownership
Adding additional owners to a corporation is a simpler process in comparison to an LLC.
Adding owners to an LLC can be a difficult process as companies that are efficiently run would not dilute a current shareholder but would only allow new owners to buy in at an appropriate price. This option might not always be available which may make LLCs unattractive to investors as they like their investments to be protected.
Also, Venture capitalists prefer to focus on liquidity events. Conversion of equity investment into profits for VCs, startups typically need to IPO or to be brought be another company. It is very difficult to transfer or sell partial ownership of an LLC. A corporation provides built in safeguards to determine how shares are issued and therefore simplifies the addition of owners.
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