Category Archives: C corporations

Corporate Structure For A Crowdfunding Business

Crowdfunding Organizational Structure

I am asked this question so often, I thought it would be worthwhile to post a diagram of a relatively simple organizational structure for a Crowdfunding business.

If I’ve done this right, the diagram should be self-explanatory. Nevertheless, I’ll make one point about choosing the right entity.

When you start the business, you have to decide whether to form the Parent (see the diagram) as a limited liability company or as a C corporation. For the reasons discussed at length here, the right answer is almost always a limited liability company. But sometimes an institutional investor will insist on a C corporation, probably because the investor itself has limited partners that are tax-exempt entities and want to avoid paying tax on “unrelated business taxable income.” And if they’re investing enough money you’ll do what they want, despite the extra tax cost for you personally (that’s why they call it capitalism).

Until and unless that happens, use the limited liability company. It’s easy to switch if you have to.

Questions? Let me know.

C Corp vs. LLC: What’s the Right Choice?

Ryan Feit, the CEO of SeedInvest, just published a great piece in Inc. Magazine about the pressure some entrepreneurs feel from venture funds to convert from a limited liability company to a C corporation. Ryan points out that the tax cost associated with a C corporation often makes the LLC the better choice.

It’s a question I’m asked all the time. And like Ryan, I normally come out on the side of the LLC for Crowdfunding companies, at least so far.

To flesh out the issue, I’ve written an online pamphlet describing the main characteristics I’m thinking about when I recommend LLC or C corporation. If you want to understand why corporate lawyers seem so isolated at social gatherings, take a look.

Choosing the Right Legal Entity Flyer

Questions? Contact Mark Roderick.

Crowdfunding? Form a “C” Corporation

One of the earliest decisions for every entrepreneur is the form of his or her company – whether a C corporation, an S corporation, a partnership, or a limited liability company. Designed as the perfect business entity, combining the flow-through tax treatment of a partnership with the liability protection of a corporation, the LLC is the first choice of many.

Things look different in the Crowdfunding universe, however. A company raising money on the Internet – whether in a true Crowdfunding offering or in a Rule 506 offering to accredited investors – will by definition end up with lots of investors, at least dozens, perhaps hundreds. Practically speaking, a company with dozens or hundreds of investors must be a C corporation.

Start with the tax filing requirements for partnerships, LLCs, and S corporations. At the end of each tax year the company must send a K-1 schedule to each owner. More exactly, two K-1 schedules, one for Federal taxes and one for state taxes. If a company has a dozen investors preparing all the K-1s is hard enough. For a small company with 100 investors the burden would be untenable.

On top of that, some states impose a per-head fee based on the number of owners. In New Jersey, for example, the fee is $150 per owner. Multiply that by 100 or more and we are talking about a serious cost for a startup company.

The lesson is unavoidable:  absent very unusual circumstances, a crowdfunded company must be a C corporation.

But that does not mean that all of the LLCs looking to the JOBS Act for funding will have to convert to C corporations. Instead, we anticipate that an existing LLC will form a separate C corporation as a member, and that the “crowd” investors will own stock in that company. The LLC will issue only one K-1 schedule and the separate C corporation will count as only one owner, despite having hundreds of stockholders.

For example, suppose Newco, LLC wants to raise $500,000 in exchange for 30% of its stock. Newco, LLC will issue 30% of its stock to a newly-formed C corporation, Investor Corp, Inc. Investors will purchase stock in Investor Corp, Inc., not Newco, LLC.

Using a C corporation will potentially impose a second level of tax if Newco, LLC is sold, and investors who purchase stock in Investor Corp, Inc. will not be entitled to write off “pass thru” losses for tax purposes. But in the Crowdfunding universe, that’s the lay of the land.

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