Question: Does one need to switch an LLC to a corporation to raise VC funding? Would you recommend starting out as a corporation pre-money or as an LLC?
The short answer is yes, you have to be a corporation to raise VC funding
VCs will want you to be a C-Corp for a few specific reasons. The main advantage of an LLC over a C-Corp is that the taxes are not flow through. In other words, your company’s tax situation will not hit the bottom line of the VC. As VCs are generally structured to be flow through tax entities, if your company was a LLC, your tax situation would flow through the VC and directly to their investors. This is not a good place to be and VC investors demand that we only invest in C-corps to stop this problem.
And you should be happy, because if this wasn’t the case you’d get nagging phone calls every year from every investor in a VC fund looking for that tax documents. 🙂
The second issue is issuing stock to employees. Since stock options are the chief motivator of employees at a startup, you need have a stock option plan. In a LLC, there is no concept of stock ownership. It’s about “unit” ownership and it’s nearly impossible to mimic a standard stock option plan in the world of “units.”
Before raising money, you should feel free to start off as a LLC. In the “old days” (ten years ago, it was time consuming and costly to convert from a LLC to a C-corp, but these days it’s much much easier.