If you are looking to disrupt a market and aspire to launch the next Facebook or Uber, then you should likely form a C corporation. In a previous post, Entity Formation Series Part II – When Type of Entity Should You Form?, I told you that a C Corporation should be used if you have a market-disrupting business model. But, why is this the case?
Simply put, if your company is seeking large-scale investment(s), then your business is going to want to have the ability to easily split up ownership of the company between a multitude of investors, over multiple rounds of funding and hopefully be acquired or go public at some point down the road. Additionally, you are usually going to want your company to have different levels of ownership, each with varying levels of rights. Corporations’ use of shares as representations of ownership interests and the availability of multiple classes of stock allows corporations to create multiple levels of ownership rights, to divide their ownership interests into tiny fractions, and to distribute millions of these fractions (separated into various levels of ownership) to numerous investors. This makes things easy for investors looking to fund a company.
Although LLCs, from a technical standpoint, can utilize ownership “units” to accomplish many of the same things that a corporation can with shares, the LLC model - for now - has yet to eclipse the corporate model as the favorite entity vehicle for VCs and other institutional investors due to practical aspects surrounding the investment world.
One of these practical aspects is simply the fact that the corporate form has been around significantly longer than the LLC. And by “significantly” I really mean a very long time. To provide some perspective of the vast difference in how long each form has been around consider this: the idea of corporations dates back to ancient Rome and the Dutch East India Company was a corporation; in contrast, LLCs only came into existence about 40 years ago.
While corporate laws have certainly evolved since ancient Rome and the days of the Dutch East India Company, the extensive history of corporations and the length of time during which corporate law has had a chance to evolve has resulted in corporations having much more established and widely accepted legal rules than LLCs. As a result, attorneys, judges, investors, and business people in general are more comfortable with the corporate form. In addition to being more comfortable, the people involved with investors and most large companies have developed extensive knowledge and widely accepted techniques for completing just about every type of transaction that a corporation wants to undertake.
People generally like to stick with what they know and are familiar with, so - for the immediate foreseeable future - corporations are the best option for the select few, highly-ambitious startups looking to make it big. This is the case because investors are more comfortable and familiar with corporations than other entity vehicles, because of the ease of creating and dividing numerous ownership interests with differing rights, and because the laws surrounding corporations have less uncertainty than LLCs or other entity forms. What it boils down to is that being a corporation makes large investors more comfortable and, therefore, removes one potential barrier for receiving that first or next big round of investment.
To determine which state you should form your business in, see my Post: Entity Formation Series Part IV - Where to Form your Entity: Texas vs. Delaware.