I have heard some variation on this question many times over the years. The answer to what sort of entity you should use when forming your business is a complex one that will depend on many factors and you should certainly consult your accountants, lawyers and tax advisers (and probably not your uncle, unless he happens to be one of the foregoing).
However, as I have posted in great detail before, one thing I can say with a fair amount of certainty is that, if you intend to raise venture capital, you should almost never use the LLC form. There are many reasons for this -- most of which I discussed in this prior post. But one point I made deserves some additional flavor. I noted, almost in passing, that
it is not possible to do an IPO with an LLC. Any LLC that wanted to go public would be required to first convert to a corporation anyway with potentially very adverse tax consequences
I recently was asked why it is "impossible" to do an IPO with an LLC. This is a good question, as there are certainly no federal or SRO prohibitions on doing an initial public offering as an LLC. In fact, there are publicly traded LLCs -- Fortress and OchZiff come to mind. More below the fold.
However, LLCs are creatures of state laws and it is the state laws that often make it impossible (or exceedingly difficult) to do an initial public offering of an LLC. For example, there are states that do or did not allow the free exchange of LLC interests. Also, there are states that require an LLC to dissolve when a member dies and states that require all LLCs to dissolve after a set period of time, ex. 30 years. All of these terms would make an IPO impossible without first converting the LLC to a different entity/state.
These laws are in flux and often a state with a more antiquated LLC statute will update it. Unfortunately, the existing LLCs will still have the old terms in their operating agreements. Sometimes an amendment will be possible, it depends on the terms of the operating agreement and votes required, but it could be tax painful or logistically difficult.
Even if you formed your LLC in a state that has an IPO friendly set of statutes (Delaware comes to mind), in my experience an IPO remains practically impossible because of the underwriters. Underwriters do not want any hair on an offering -- anything that could give a potential investor pause. Often, an underwriter will force a company formed outside of Delaware to convert to Delaware just for purposes of the IPO. To try to go to market with an exotic IPO equity like an LLC membership interest is simply a non-starter for anything that is already risky, i.e. a tech start-up. In today's IPO market, it is hard enough to get underwriters interested in a start-up IPO, it would take extraordinarily exceptional circumstances to convince them to underwrite an LLC.
My final thought is, if you are founding a company that hopes for venture capital, why ratchet up your level of difficulty from the beginning? You will have enough business challenges -- why give yourself structural challenges too. If you know you are creating a company that will need VC and you hope in your heart of hearts to someday do an IPO, why not instead take the path of least resistance when you form your company and use a C corporation? (Again, this is not to say that LLCs are not VERY useful in many other circumstances.) Click Here to Read More..