Comments on: You kids and your LLCs http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/ The Startup Blog Network Mon, 15 Mar 2010 15:05:50 +0000 http://wordpress.org/?v=2.7 hourly 1 By: LeeDrake http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1689 LeeDrake Sun, 05 Apr 2009 05:17:55 +0000 http://www.coloradostartups.com/?p=2698#comment-1689 But isn't there a significant difference in the tax rates between LLC/S and C? Aren't the C corps taxed at capital gains rates, and the LLCs and S's at the owner's income tax rate (regardless of if they leave in the company or not). I'm not an accountant (can you tell) but this was how it was explained to me 12 years ago when I formed my company :) Cheers, Lee But isn't there a significant difference in the tax rates between LLC/S and C? Aren't the C corps taxed at capital gains rates, and the LLCs and S's at the owner's income tax rate (regardless of if they leave in the company or not). I'm not an accountant (can you tell) but this was how it was explained to me 12 years ago when I formed my company :)

Cheers,
Lee

]]> By: Cookie Monster http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1688 Cookie Monster Sun, 05 Apr 2009 04:37:51 +0000 http://www.coloradostartups.com/?p=2698#comment-1688 LLC's and S corps are not required to distribute profits. However, members/shareholders are required to pay taxes on profits regardless of whether they were distributed or not. My take: distribute 40% to cover taxes, keep 60% in company until you've got a nice cushion. LLC's and S corps are not required to distribute profits. However, members/shareholders are required to pay taxes on profits regardless of whether they were distributed or not. My take: distribute 40% to cover taxes, keep 60% in company until you've got a nice cushion.

]]> By: ldrake http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1675 ldrake Tue, 31 Mar 2009 19:28:23 +0000 http://www.coloradostartups.com/?p=2698#comment-1675 I know there is the issue of "C" corps being double taxed on retained earnings (if they take those earnings out as profit later). On the other hand, the ability to retain earnings is what kept my "C" corp alive last year. We had enough cash stored up that we could weather a downturn in the economy and still be cash positive by the end of the year. That's something that becomes much more difficult if you must push all the profit out to your shareholders each year. Retaining earnings is what allows a company to weather not only the upturn growth but the downturn economy without risking personal funds to do so. With the new stimulus allowing us to write down losses this year against past profitable years, that only increases the value of having those earnings around to keep your cash rich position during hard times. Run in the black - it only makes sense :) Remember - Cash is King! I know there is the issue of "C" corps being double taxed on retained earnings (if they take those earnings out as profit later). On the other hand, the ability to retain earnings is what kept my "C" corp alive last year. We had enough cash stored up that we could weather a downturn in the economy and still be cash positive by the end of the year. That's something that becomes much more difficult if you must push all the profit out to your shareholders each year. Retaining earnings is what allows a company to weather not only the upturn growth but the downturn economy without risking personal funds to do so. With the new stimulus allowing us to write down losses this year against past profitable years, that only increases the value of having those earnings around to keep your cash rich position during hard times. Run in the black - it only makes sense :)

Remember - Cash is King!

]]> By: hankheyming http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1667 hankheyming Mon, 30 Mar 2009 03:51:25 +0000 http://www.coloradostartups.com/?p=2698#comment-1667 Jennifer -- I appreciate your questions. You are exactly right that there is no federal or SRO prohibition on doing an initial public offering as an LLC. You are also correct in noting that some LLCs are publicly traded, OchZiff is another. However, LLCs are creatures of state laws and there are multiple states that do not allow free exchange of LLC interests which would make an IPO impossible without first converting to a different entity/state. Even if you formed your LLC in a state that has an IPO friendly set of statutes, in my experience you would still have a practical near impossibility because of the underwriters. It is hard enough to get underwriters interested in a start-up IPO, it would take an extraordinarily exceptional circumstance to convince them to underwrite anything non-standard, e.g. an LLC. I guess my final thought is, why ratchet up your level of difficulty as a start-up? If you know you are creating a company that will need VC and that hopes someday to IPO, why not take the structural path of least resistance? (Again, this is not to say that LLCs are not VERY useful in many other circumstances.) As for restricted stock v. options, the usual drawback to doing restricted stock in a start-up is that the recipient may have to pay taxes on grant (if an 83b election is made) or on vesting. Either way, the stock is not typically liquid in a start-up (so you can't sell it to pay the taxes) and most founders/start-up employees are in cash conservation mode. -- Hank Jennifer — I appreciate your questions. You are exactly right that there is no federal or SRO prohibition on doing an initial public offering as an LLC. You are also correct in noting that some LLCs are publicly traded, OchZiff is another. However, LLCs are creatures of state laws and there are multiple states that do not allow free exchange of LLC interests which would make an IPO impossible without first converting to a different entity/state.

Even if you formed your LLC in a state that has an IPO friendly set of statutes, in my experience you would still have a practical near impossibility because of the underwriters. It is hard enough to get underwriters interested in a start-up IPO, it would take an extraordinarily exceptional circumstance to convince them to underwrite anything non-standard, e.g. an LLC.

I guess my final thought is, why ratchet up your level of difficulty as a start-up? If you know you are creating a company that will need VC and that hopes someday to IPO, why not take the structural path of least resistance? (Again, this is not to say that LLCs are not VERY useful in many other circumstances.)

As for restricted stock v. options, the usual drawback to doing restricted stock in a start-up is that the recipient may have to pay taxes on grant (if an 83b election is made) or on vesting. Either way, the stock is not typically liquid in a start-up (so you can't sell it to pay the taxes) and most founders/start-up employees are in cash conservation mode. — Hank

]]> By: David G. Cohen http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1664 David G. Cohen Mon, 30 Mar 2009 00:47:04 +0000 http://www.coloradostartups.com/?p=2698#comment-1664 gotcha - see my follow up post today gotcha - see my follow up post today

]]> By: Steve Murchie http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1663 Steve Murchie Mon, 30 Mar 2009 00:20:44 +0000 http://www.coloradostartups.com/?p=2698#comment-1663 Sorry I was referring to operating overhead and expense. C-corps require an added level of reporting, taxation and structural administration that can be PITA in a seed stage company. I agree that LLC to C is more of a reorg than S to C, but what I'm suggesting makes the timing appropriate to the stage of the company. Sorry I was referring to operating overhead and expense. C-corps require an added level of reporting, taxation and structural administration that can be PITA in a seed stage company. I agree that LLC to C is more of a reorg than S to C, but what I'm suggesting makes the timing appropriate to the stage of the company.

]]> By: More on LLCs | Colorado Startups http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1660 More on LLCs | Colorado Startups Mon, 30 Mar 2009 00:05:30 +0000 http://www.coloradostartups.com/?p=2698#comment-1660 [...] days ago, I lamented about how much of a pain LLCs can be for investors. The comments were [...] [...] days ago, I lamented about how much of a pain LLCs can be for investors. The comments were [...]

]]> By: David G. Cohen http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1659 David G. Cohen Sun, 29 Mar 2009 23:23:05 +0000 http://www.coloradostartups.com/?p=2698#comment-1659 Huh? Going for s to c is a simple change. Going from LLC to c is a total reorg! Huh? Going for s to c is a simple change. Going from LLC to c is a total reorg!

]]> By: Steve Murchie http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1658 Steve Murchie Sun, 29 Mar 2009 23:08:25 +0000 http://www.coloradostartups.com/?p=2698#comment-1658 I'm very anti S-Corps in the early stage, since it prevents the company from having anyone as a shareholder who is not a "natural person". I'd estimate that more than half of the angel investors I know invest through some kind of entity (typically an LLC), thus you immediately force a conversion from S-Corp to C-Corp in an angel round, which adds a ton of overhead and expense. Starting as an LLC, you can convert at the time of institutional investment much more easily, and you'll have the capital to support the legal fees... I'm very anti S-Corps in the early stage, since it prevents the company from having anyone as a shareholder who is not a "natural person". I'd estimate that more than half of the angel investors I know invest through some kind of entity (typically an LLC), thus you immediately force a conversion from S-Corp to C-Corp in an angel round, which adds a ton of overhead and expense. Starting as an LLC, you can convert at the time of institutional investment much more easily, and you'll have the capital to support the legal fees…

]]> By: JenniferNaylor http://www.coloradostartups.com/2009/03/27/you-kids-and-your-llcs/#comment-1656 JenniferNaylor Sun, 29 Mar 2009 11:21:54 +0000 http://www.coloradostartups.com/?p=2698#comment-1656 Hank, are you sure about the IPO rules? I don't believe that Blackstone Group converted; E*Trade and Seagate remain LLCs. It may be more difficult to do an IPO as an LLC, but I don't believe it's not possible. With all the scrutiny of the last few years on options, I have to think that they've lost their attractiveness, and I hear of companies that are now using restricted stock as bonuses. One attractive aspect of the LLC structure is that companies have more flexibility in how they claim income to the IRS and in that case, they can avoid higher taxation on certain types of income such as capital gains. While there is a lot of ink about how much VCs dislike LLCs, I think the more interesting story is on companies that remained LLCs despite VC pressure. Segway, LLC was financed by Kleiner Perkins, and I'm sure there are others. Hank, are you sure about the IPO rules? I don't believe that Blackstone Group converted; E*Trade and Seagate remain LLCs. It may be more difficult to do an IPO as an LLC, but I don't believe it's not possible.

With all the scrutiny of the last few years on options, I have to think that they've lost their attractiveness, and I hear of companies that are now using restricted stock as bonuses.

One attractive aspect of the LLC structure is that companies have more flexibility in how they claim income to the IRS and in that case, they can avoid higher taxation on certain types of income such as capital gains.

While there is a lot of ink about how much VCs dislike LLCs, I think the more interesting story is on companies that remained LLCs despite VC pressure. Segway, LLC was financed by Kleiner Perkins, and I'm sure there are others.

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