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LLC or Corporation for angel investors
haamoniismooth
subscriber Posts: 1
Is it better to have a LLC or a corporation when seeking seed capital from individual angel investors? What are the pros and cons of each?
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Unless you have some special circumstances, I would suggest creating the operating agreement before engaging with investors.
Robert Johnson
http://www.laughlinusa.com/llcvscorp.asp</A>
As a business person depending on your business plan an its exit strategy is what you should use to determine what type of corporation you need to set up.
I have always been told be prepared to give up half the company or more depending on how much you bring to the negotiating table.
However one of my businesses has ended up with investors offering to get only 10%.
Many deals have conditions in them that when investor wants to sell they offer the shares to you first. So you have option to buy back your business stock.
There are many reasons to favor a corpaoration but the main ones include:
(1) Having a well-known, easy to understand corporate structure so that investors know what they are buying (most funds refuse to invest in an LLC).
(2) Company and investors spend far less in legal and accounting fees.
(3) Reducing risks inherent in LLC operating agreements and in LLC governance.
(4) Ability to create stock option plans.
(5) Creating tiered classes of preferred stock for future investment rounds is more straightforward in a corporation than an LLC.
(6) Complexity and sometimes dire tax consequences involved in converting the LLC to a corporation down the road (which is almost inevitable), or being acquired by a corporation.
(7) Following established business norms for the industry rather than going against the trend is a sign of willingness to play by the rules, and also knowing what you`re doing. Same reason you wear dress shoes rather than sneakers when meeting an investor for the first time.
Every situation is unique and there are sometimes situations where an LLC works. For holding companies, partnership-like enterprises, family businesses that are not expected to grow, financial instruments, etc., LLCs are often preferred. However, as a startup company you want to iron out the unique details and be as generic as you can in your corporate setup so that you are attractive to investors and prepared for rapid, trouble-free growth rather than increasing structural complexity.
For similar reasons you don`t want to put nonstandard terms (like a right of redemption or a right of first refusal in favor of the company) into your investment contract. There is a long list of stock terms that are common to startup investments, but a $1M investment does not necessarily buy the investor a right to preferred stock or all these terms, particularly if you are expecting larger rounds later. That is on the low side.
All of this assumes you are following a standard start-up model, i.e. an angel round followed by larger preferred VC or institutional investment rounds, taking on a growing number of principals and workers who will receive equity compensation, company geared to retaining earnings and reaching a liquidity event as opposed to long term cash dividends.
Hope this helps.
You wrote "Unless you have some special circumstances, I would suggest creating the operating agreement before engaging with investors."What is an "operating agreement"?Thanks. Noel L. Lim
An Operating agreement is the document that describes how an LLC will "operate". They are somewhat similar to by-laws for a corporation, but they are more significant.
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