According to the Congressional Research Service, in 2015 around 64% of corporations with fewer than 5 employees were structured as LLCs or S corps. This suggests a majority of entrepreneurs choose to start their businesses as an LLC which, of course, makes sense. They get to invest in their business and immediately capture any losses as tax deductions against their other income via the annual K1. It is a great tax advantage.
The cost of maintaining an LLC is also similar to a C corp. BUT should there be any profits, those are directly passed to the shareholders – and in that case, it’s the shareholders who pay tax, not the LLC. This system was great when corporate taxes were 40%. Today, with the new corporate tax rates, LLCs are not necessarily as advantageous.
That said, raising capital through the crowd as an LLC is absolutely possible and works well. The main benefit is to avoid converting the corporation to a C corp until all of the losses (and tax advantages for founders) have been recouped. There are really two ways to go about it:
- Simply keep the LLC intact and update the operation agreement to allow thousands of shareholders and permit raising capital through crowdfunding.
- Alternatively, still maintain the LLC but create a new C corp to hold the company’s IP. Then, issue shares of the C corp to all the new investors. This way the LLC itself will only issue annual K1s to the original shareholders, who predate the fundraising round from the crowd.
Down the road some entrepreneurs may want to convert to a C corp to eliminate the operating agreement and K1 requirements. Either way, raising capital is the right way to grow a business and I believe raising through equity crowdfunding is the right way to stay in control. After all, what you get when raising through the crowd is an army of brand ambassadors, not VCs sitting on preference shares.
