by Guest Columinst
Peter Rothberg
Partner
Duane Morris LLP
1540 Broadway, 14th Fl
New York, NY
Many entrepreneurs think that their new startups need to be organized as limited liability companies (LLCs). They, and you, might be surprised to learn that’s not always the case. One of the primary issues to consider is that of losses; a familiar concern for startups in the first years of operation. Yes, a founder who is active in the business can use losses from LLC operations to offset almost any kind of income. But until the LLC startup is sold, or generates income from its operations many years down the line, the amount of other founder income that LLC startup losses can shelter is limited to the founder’s investment in the startup. This does not typically amount to big bucks.
Compound that with VC reluctance to invest in LLCs, difficulty in incentivizing LLC employees with options, and higher cost. Now add the significant hassle of running the financial books for LLCs (managing capital accounts and sending out K1 tax returns to LLC members). Considering all that, starting your new company as an LLC looks… well…daunting, to say the least. Instead, founders of startups should look into a more typical startup planning model for VC financing: a corporation.
So, a few practice tips before you select the legal vehicle for your startup
venture:
1. Consider the timing to institutional fundraising;
2. Consider the type and amount of Founder capital contributions to the startup, and the nature and amount of the Founder’s income from sources other than the startup; and
3. Measure the value of the tax benefits provided by use of an LLC structure against the additional costs that use of that structure will entail, especially if seeking outside institutional equity investment is part of the financial plan.
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