This is one of the earliest questions that comes up when an entreprenuer or group of founders want to formalize their company or business relationship. The usual advice is that if you have current income and are not looking for investors and will not have to bring on other owners in the near future, an LLC is usually a good choice. They are flexible, light on required paperwork and are similar to doing business as a sole proprietor, assuming you continue to have the LLC disregarded for tax purposes. Sole member LLC’s are inherently flexible. Multi-member LLC’s are also flexible, but will require a carefully crafted Operating Agreement to cover certain actions each member can take, breakdown of membership interests, profits, and exit options. LLC’s are great vehicles to hold real estate.
Now if your company is seeking investors, especially institutional investors of either angel or VC level, it goes without saying that you will need to be set up as a corporation. Usually the investors will want a Delaware corporation. This will allow the corporation to issue preferred shares with various beneficial provisions in favor of the investors; right to convert to common, liquidation rights, registration rights, anti-dilution provisions, etc. While all of these are technically possible to do in an LLC format, they are not as commonly used. Investors feel more comfortable with the corporation form, notably c-corps, and they are the ones putting up the money so they usually get their way. Also, and more importantly, most investment funds have prohibitions in their organizational documents prohibiting investments in LLC’s to ensure that the fund does not receive any unrelated business income tax (UBIT). While you will hear some buzz around the internet, and maybe directly from some startups that institutional investors invested in their LLC, this is most likely through a “blocker” corporation, which is essentially a sole purpose corporation owned by the fund which holds the interest in the LLC. Most investors do not like this structure as it has its drawbacks, but it is done. Honestly, if you are running a startup, you would rather be negotiating investment terms and trying to get the best deal that you can, so you don’t want to already have one foot in a hole with respect to your entity situation.
Of course, no matter which entity you choose, you can always later either convert (depending on what state your company was formed in) or merge the existing LLC or corporation into another that you have formed. This will of course, require legal assistance, and is not always an easy process, especially if your company has signed certain non-assignable contracts or has other liabilities. But, as with most things, there is a way that it can be done.
