Startup Incorporation - Why Investors Prefer C Corps (2024)

FAQs

Startup Incorporation - Why Investors Prefer C Corps? ›

No Pass-Through Taxation

C corporations provide the legal and tax structure that aligns with the needs and preferences of venture capitalists, making them the preferred choice for attracting investments. C-corps offer more flexibility to VC investors than S-corps. Some VCs cannot invest in any other type of entity due to managing public funds.

No Cap on Shareholders

Unlike other business entity types, such as S-Corps which cannot have more than 100 shareholders, C-Corps have no restrictions on the number of shareholders. This is important for startups that plan to go public or attract a large amount of investors.

Business owners who choose the C corporation do so because (a) they prefer the corporation as an entity over other statutory entities such as LLCs or non-statutory structures such as a sole proprietorship or general partnership, and (b) they prefer to have the corporation taxed as a separate entity or do not qualify to ...

Because S Corps are not taxed at the corporate level, you can avoid double taxation and save money on taxes. However, if you plan to reinvest profits back into the company, a C Corp may be more beneficial, as they can retain earnings at lower tax rates.

Unlike S corporations and LLCs, C corp investors are not subject to pass-through taxation, have much simpler, investor-friendly tax filing, and may even be exempt from taxes if they qualify for the Qualified Small Business Stock exemption.

Investors do not like the tax implications of an LLC because as a partner, they'll be taxed on the entity's income even in years when no cash is distributed to them personally. VCs often avoid this structure as they don't want business profits or losses passing through to them directly.

Most startups incorporate as a C-Corp, the same structure used by Apple, Google and pretty much every large company in the United States. A C-Corp is a fully separate legal entity, responsible for paying corporate taxes and issuing annual reports. It must also appoint a board of directors.

Disadvantages of a C Corporation

Double taxation. It's inevitable as revenue is taxed at the company level and again as shareholder dividends. Expensive to start. There are a lot of fees that come with filing the Articles of Incorporation.

Taxation under Subchapter C will result in lower taxes than taxation under Subchapter S. Distributions will not be made to shareholders. You plan on an IPO or seeking investors not allowed for an S corporation. You want shares to be freely transferable.

How do C Corp owners get paid? ›

Officers of C corporations are strictly paid on a salary basis. They may be able to obtain bonuses, but their primary source of income is their salary. In an S corporation, an owner can choose to take regular draws or distributions in addition to their normal salary.

One reason to convert your S-Corp to a C-Corp is to generate more funding. One of the benefits of a C-Corporation is that is has more flexibility when raising capital. Since C-Corps can have an unlimited number of shareholders, it is usually much easier to attract investors.

Double taxation on corporations

Businesses that are registered as C corps (and LLCs that elect to be treated as corporations) are taxed twice on business profits. The corporation first pays taxes on its profits, but then stockholders must pay personal income taxes on the dividends paid from the company's profits.

From a tax standpoint, C corps also provide advantages for smaller business owners, such a mechanism for avoiding the self-employment tax and greater flexibility when it some to deductions, salaries, and dividend distributions.

However, C-corps may offer more tax benefits in the long run. While LLCs are pass-through entities where profits and losses pass to the owners' personal returns, C-corps allow business losses to offset income earned. C-corps can also potentially qualify for more business tax deductions.

Stock ownership restrictions.

An S corporation can have only one class of stock, although it can have both voting and non-voting shares. Therefore, there can't be different classes of investors who are entitled to different dividends or distribution rights. Also, there cannot be more than 100 shareholders.

Advantages and Disadvantages of a C Corporation

They are also subject to greater regulatory scrutiny, which can increase the company's legal expenses. Limited liability for directors, shareholders, and other company officers. C corps can raise capital by issuing and selling shares of stock.

Venture capital firms prefer to invest in: high-potential ventures.

They prefer how C corporations are taxed

One of the benefits of C corporations is in the way they are taxed – they pay taxes on gross revenue minus expenses (their profit), and once dividends are distributed, it's up to the shareholders to pay income tax on what they've received.

In addition to strong liability protection, venture capitalists and other institutional investors prefer Delaware C-Corps because they provide more flexibility in corporate governance. Compared to other entity types, a Delaware C-Corp can more easily transfer shares of its corporate stock.