Startup Company

Why do investors prefer corporations?

There are a few main reasons that corporations (taxed as C corps) are the most attractive option to investors, including limited liability, taxes, and ownership transferring ease.

• Limited Liability
  Corporations offer limited liability for shareholders (owners). This means that shareholders are not personally responsible for any of the business’s unpaid debts. A limited liability company (LLC) offers this advantage as well, while sole proprietorships and general partnerships do not.
• Taxes
  Corporations are subject to a federal corporate tax and, potentially, a state-level corporate tax. Shareholders are taxed, as well, but only on the dividends (payouts) they receive. This is known as double taxation. Double taxation can be appealing to investors because it means they only have to worry about paying taxes on money they’ve been paid. If they receive no dividends—which is a common startup scenario because profits are usually put straight back into the business—they pay no taxes.

  On the other hand, LLCs are pass-through entities, meaning profits and losses pass directly to members (owners). This option is often less appealing to investors because it means that—even if they didn’t receive any dividends—they have to pay taxes on the business’s earnings. While some LLCs can elect to be taxed as C corps, investors are generally still more drawn to corporations, in part because of ownership transferring ease (see below).

• Transferring Ownership
  It is generally easier to transfer corporate ownership than it is to transfer LLC ownership. Transferring corporate shares typically involves trying to sell to other shareholders, then, if there are no takers, seeking outside buyers; getting permission to sell is not usually required. Transferring LLC interest generally requires, at a minimum, a vote of approval from the other members.

What is pre-seed funding?

Pre-seed funding occurs in the earliest stages of a startup company’s inception. At this stage, the startup has likely created a proof-of-concept or minimum viable product. The market opportunity for the product is identified. The founders may be starting to hire employees, but the team is small.

Money usually comes from the founders or from friends and family, but generally not from investors like venture capitalists. Because of this, money raised in the pre-seed round is typically in the thousands, rather than the millions.

What is seed funding?

Seed funding is the first time many startup companies seek outside investors. Family and friends may continue funding in the seed round, but founders will focus more on generating investments from incubators, angel investors, and venture capitalists.

By this point, the product may be ready for the market, and a strategy for entering the market may be in place. Money raised in the seed round might be used to expand the team, conduct market research, continue product development, and bring the product to market.

As with all funding rounds, money raised through seed funding can vary widely: founders might hope to raise anywhere from $100,000 to $2 million (or more).

What is series funding?

Series funding encapsulates the later stages of funding rounds. We discuss rounds A, B, and C below, but some startup companies may never reach series funding (by choice or by circumstance). Conversely, some startups may fundraise into even later rounds, such as series D or E.

• Series A Funding
  Series A funding occurs after a minimum viable product is in the market, customers have been found, and revenue is being generated (though likely not profits). If series A funding happens when a product is still in early development, investors are likely to want a larger return, as they’re assuming greater risk than if they invested in a more developed product. By this stage, the primary investors are venture capitalists.

  Successful series A rounds can bring in $5-20 million. Valuation is increasingly important by series A, even though calculating an accurate company valuation is difficult.

• Series B Funding
  Series B funding takes place when startups have increased stability—hiring talent, a substantial customer base, and increased revenue may all play a part. Businesses at this stage focus more on growth than development, and they come with less investment risk. Series B investors are primarily venture capitalists and private equity firms, with funds going toward expansion to meet growing demand.

  Series B financing can generate $10-30 million from investors. Since startups are theoretically more stable and developed by series B, the company’s value is easier to calculate.

• Series C Funding
  Series C funding is reserved for businesses that have proven successful with a strong reach and customer base. Businesses that make it to this stage seek funding from venture capitalists and private equity firms to deepen their success. Series C funding can top $50 million.

What is an Initial Public Offering?

An initial public offering (IPO) is the final hurdle many startups are trying to clear, the shift from being a private company to a public one. Few startups reach this stage.

Benefits of going public include raising more capital and an opportunity for founders and early investors to make returns on their investments in the company.

Disadvantages include a loss of company control, potential disclosure of company secrets, and a focus on stock price as opposed to company operations.