A Delaware C-Corp or an LLC? Which is the Best for My Tech Startup, and Why?
A Delaware C-Corp or an LLC? Which is the Best for My Tech Startup, and Why?
Setting up your new business involves choosing the entity type that determines how your company will operate. If you don’t incorporate, by default you will be a sole proprietorship or a general partnership (least recommended - we will talk about this in another post). New tech entrepreneurs often ask,
“which corporate entity is best for my startup?”
A Limited Liability Company (LLC) is an excellent choice for some businesses, e.g., a real estate investment company that owns multiple properties. However, if you are a tech company aiming at raising capital by investors for eventual high growth, the recommended option is a Delaware C Corporation (C Corp).
Similarities and Differences
Let’s consider a few similarities between an LLC and a C-Corp.
Tax - By default, an LLC does not pay taxes on its income. The tax is ‘passed through’ and paid individually by owners based on their profit distribution. Owners could choose the LLC to be taxed as a corporation, especially if substantial business profits need to be retained in the business, thereby lowering their overall taxes. A C-Corp, however, is taxed at the corporate level, and then the shareholders are also taxed individually upon receiving profit distribution. But then again, early-stage C-Corp startups rarely declare dividends - most of the profits are reinvested into growing the business during the initial years. The real upside for founders is the appreciation in stock value in a future stock sale.
Liability Protection - Both entity types are legally separate from their owners. Should things go wrong, the business gets sued and not the owners personally (unless the owners commit fraud).
Intellectual Property (IP) - If you are a high-growth tech startup, your IP can include, for example, legal ownership of your company name, the code that runs your app, patents, and trademarks. Ownership by your LLC or C-Corp of these IP assets has two major benefits:
The IP provides a rationale for each contributor’s equity stake.
No co-founder can walk away with the company’s IP and later stake a claim jeopardizing the company’s future.
And a few differences …
Investors – A tech startup needs investors to provide capital in exchange for company equity. Most venture capitalists (VCs) and angel investors will prefer that your company be a Delaware C-Corp. If you haven’t initially incorporated this way, it may be costly and time-consuming to later convert into a Delaware C-Corp. But why Delaware?
Business Friendly – Delaware courts have been known to uphold business decisions made by the board over most business matters pursuant to the ‘business judgment rule’. This means that a court will not ‘second-guess’ the business decisions of a company absent conflicting interests and non-disclosures.
Quicker Dispute Resolution - Delaware courts hear cases involving business disputes more often than in other states. Therefore, Delaware judges are known for their excellent understanding of corporate law, leading to more predictable outcomes.
Bottom Line – For the above reasons, Delaware is globally considered one of the most popular jurisdictions to incorporate technology and VC-backed companies. So, for your tech startup, the answer to which corporate entity is best is a no brainer – it must be a Delaware C Corp.