Why A Tech Startup Should Form a C-Corporation
In the early stages, many tech startups seek capital from angel investors and venture capitalists. The additional capital is vital if a startup wants to lay the foundation for exponential growth. However, most investors do not have the time to become part of a Limited Liability Company, or LLC, the legal structure of choice for many new and small businesses.
Most investors are passive silent partners who do not want to become entrenched in the day-to-day operations of your business. Because of the way LLCs are structured, passive investors may steer clear to avoid pass-through taxes and other responsibilities. When you organize as a C-Corporation, you make it easier and more appealing for passive investors to become involved.
Advantages of C-Corp for Tech Startups with Passive Investors
- Avoid Pass-Through Taxes: Pass-through taxation is a key element of LLCs and S-Corporations, where the company’s taxes are paid through the owners’ individual tax returns. Investors do not like pass-through taxation because they may be taxed on the company’s profits, even if they did not receive distributions from the company. With a C-Corporation, investors are taxed only on income received in the form of distributions.
- Favorable Government Structure: C-corporations are governed by a board of directors who answer to shareholders, and who are not directly involved in the company’s daily operations. This is an ideal scenario for passive investors who do not want to be troubled with managerial decision making.
- Facilitate Employee Equity: The structure of a C-Corp enables tech startups to create stock option portfolios for their employees, providing an attractive incentive to draw new talent from the tech sector.
- Preferred Investor Rights: C-Corps are able to create different classes of stock, which means they can offer preferred stock to their investors.
- Avoid Self-Employment Taxes: If you take money out of your LLC, you will have to pay self-employment income tax on the full amount. However, when you receive dividends from a C-Corp, you only pay ordinary income tax in an amount equivalent to a reasonable salary, and you pay lower capital gains taxes on distributions that exceed a reasonable salary.
- Reassurance of Familiar Structure: Most entrepreneurs and passive investors are familiar and comfortable with the governance and taxation of C corporations, and feel more protected by a C-Corp’s bylaws. A seasoned investor may be reluctant to back a startup whose structure does not provide the same protections.
While many tech startups may feel intimidated by the notion of forming a full-scale C-Corp right off the bat, it is more expedient to do so in the long-run, especially if you want to impress prospective investors with your concept. The professionals at Windsor have the expertise to help you create a C-Corp for your tech startup with minimal hassle. Contact Windsor today, and let us help you get your tech startup off to a good start.