Raising Venture Capital Funds: LLC Vs Corporation

You can raise venture capital funds as either an LLC or a corporation. However, many venture capitalists prefer to invest in corporations. We’ll provide a quick overview of venture capitalist funding and why venture capitalist firms prefer to invest in corporations.

Venture Capital Basics

Venture capitalist firms are investors who supply young companies and entrepreneurs with the funding required to get businesses off the ground in exchange for company equity. Because this investment is often substantial, venture capitalists invest in start-ups and small businesses with outstanding growth potential. Venture capitalists can take up to 50% of a new company’s ownership, hoping to make a significant return on investment (ROI). This strategy is risky but can have considerable rewards. For example, Facebook and Twitter both received venture capital funding and are now worth billions of dollars.

To help protect their investment, venture capitalist firms may also offer business mentoring and/or take on a role in company leadership in addition to providing funds. The relationship between the company and the investor may continue until the investor is satisfied that they’ve made enough ROI. After a certain amount of time has passed and the company is successful, its owners can also buy out their venture capitalist investors. Of course, if a company fails to make a venture capitalist sufficient ROI, the company may liquidate and pay the investor what they are owed.

How do you apply for venture capital funds?

When applying for funds from a venture capital firm, you’ll need to submit a detailed proposal, including a thorough business plan that contains information on your product or service, management structure, marketing strategy, and financial outlook. As much as possible, you need to show venture capitalist investors that your company is poised for success and has the potential to make investors a large chunk of change.

Do you need a license to raise venture capital funds?

You don’t need a license to raise venture capital funds in the US. However, you will need to obtain all required business licenses to ensure that company is operating on the up-and-up.

Venture Capitalist Funding: LLCs Vs Corporations

When you’re starting a business, one of your main concerns is business entity type. Often, this comes down to forming an LLC versus a corporation. Many new and small businesses opt to form LLCs, which have a flexible management structure. However, if you’re interested in pursuing venture capitalist funding, incorporating is typically the way to go.

Why do venture capitalist firms prefer to invest in corporations? Here’s a brief rundown:

Predictable Management Structure

Although LLC management structure is more adaptable, corporate management structure is more predictable. Corporations must follow specific rules, such as appointing a board of directors and hiring officers. This can allow venture capitalist investors to have more control—for example, a venture capitalist firm might have a seat on the board—and for the company itself to be more stable. Additionally, in many states, corporations are legally required to adopt and adhere to corporate bylaws, which may provide investors with an additional sense of security.

Corporate Vs Pass-Through Taxation

Although corporations are subject to double taxation, once at the level of the corporation and then again at the level of the shareholder, corporate taxation can actually reduce the amount of taxes venture capitalists will have to pay on their investments.

Corporate dividends are distributed to shareholders after the corporation has paid taxes on its gross income (minus expenses), and investors only pay taxes on what they receive. In contrast, LLCs are taxed as pass-through entities. LLCs are not taxed at the company level—instead, LLCs owners pay taxes on their percentage of ownership in the LLC’s profit, whether or not they made money.

Additionally, some venture capitalist firms have tax-exempt investors who would be unable to deal with funds passed through an LLC.

Stock Possibilities

Because corporations issue stock rather than simply ownership interest like LLCs, corporations offer venture capitalist investors more opportunities and flexibility.

Having stock allows venture capitalist investors to take advantage of the following:

• Preferred shares. In return for their investment, many venture capitalist firms wan to receive preferred shares, which will give them a priority claim on dividends and distributions.

• Stock options. The ability to offer stock options to employees and managers can be a powerful recruitment tool, helping to attract talent that will increase the company’s chances of success and the investor’s chances of making a large ROI.

• Stock sales. Selling stock is easier than selling ownership interest. So, owning stock in a company allows venture capitalists the option of easily selling and exiting a failing company or making a quick buck when necessary.

While it’s not impossible for a venture capitalist firm to want to invest in an LLC, there are numerous advantages to investing in a corporation. If you’re looking to attract venture capitalist firms, you’ll want to choose your business entity structure wisely. It’s a good idea to consult a business attorney before taking the leap.