Hi, I’m David G. Cohen.

Two days ago, I lamented about how much of a pain LLCs can be for investors. The comments were lively.

Many people pointed out the “double taxation” issue involved with C corporations. C Corporations pay taxes and then when money is removed from the corporation to the investors or founders, another round of taxes is imposed. On the surface, this is a good argument for an LLC but it turns out to not have much of an impact in reality much of the time.

The other issue that people pointed out is that valuable losses can be passed through to the personal taxes of the investors and founders with an LLC. While this is also true under ideal circumstances, it turns out to not be true at all in most common cases.

Victor Fleischer reached out to me by email with a thorough research paper called “The Rational Exuberance of Structuring Venture Capital Startups” he had written on this very topic in 2003. I found it to be very educational and I think you will too. It’s absolutely worth a full read (10 minutes or so) – and it’s not as long as it looks because there are many detailed footnotes and supporting references.

Here’s the gist of his paper as I read it. Many observers of the venture capital industry believe that VCs ignore LLCs primarily because C corporations are the devil they know, and secondarily because they’re focused on gains only and are not typically major participants in losses (since they are investing other peoples money and not their own, primarily). This paper goes a long way towards showing why professional investors prefer C corporations and includes many potential surprises such as:

• Tax losses are often not as valuable as they seem on paper as tax rules prohibit many investors (and entrepreneurs) from capturing the full benefit of the losses.
• Corporations are less complex than partnerships. “Friction” costs associated with LLCs may make legal costs substantially higher over time for LLCs.
• Gains are taxed more favorably when companies are organized as C corporations from the beginning (vs converting late, if that is even legally possible).
• Employee compensation issues are much more complex with an LLC than a corporation. This can cost more and can devalue “options” equivalents coming from LLCs.

In short, at least in my mind, much of the argument for LLCs as being more tax efficient ends up being an illusion and only true “on paper.”

I hope that this starts another big argument. Blogging is for learning, and your comments and participation are really helping me learn. I thank you for that.

Keep in mind the paper is a little old and some tax laws may have changed in the interim. As always, consult your attorney and accountant as I’m no tax lawyer.

Incidentally, Victor is returning to CU as an Associate Professor at the law school this June! I’m glad to welcome him back to Boulder after he spent the last few years at the University of Illinois College of Law. I’m excited that he’ll be an asset to the local entrepreneurial community once again.

Related articles

• Why Don’t Venture Capitalists Like Investing in LLC’s? (dividendsandpreferences.blogspot.com)
• S Corp’s vs LLCs (Feld Thoughts)
• Forming an LLC May Be a Wise Choice For Your Small Business (stepbysteptips.com)

« view less

Silicon Flatirons and the University of Colorado are presenting Entrepreneurship Week during the week of April 13th. Here are some events happening that week. More details and registration links for the events below are here.

Monday, 4/13
Starting Companies at CU: Technology Entrepreneurship Luncheon
11:30am – 2:00pm, University Memorial Center
CU Tech Transfer and the Boulder Innovation Center celebrate CU-Boulder faculty entrepreneurs and offer an inside ‘faculty perspective’ at a recent CU spinout. (Reservations required – Invitations offered to the public on and after Wednesday April 1.)

Tuesday, 4/14
Silicon Flatirons Center’s Entrepreneurial Mash-Up
Dairy Center for the Arts
This social event and fundraiser, connecting the current generation of Entrepreneurs to the next, will honor Brad Feld, some guy named David Cohen, Tom Lookabaugh, Sue Kunz, LeftHand Networks, and Rally Software for their contributions and impact to the Colorado entrepreneurial community and ecosystem.

Wednesday, 4/15
Feld-Weiser One-on-One: The Entrepreneurial Ecosystem
5:00pm, Wittemeyer Courtroom, Wolf Law Building
Phil Weiser, Professor of Law and Telecommunications, will interview local venture capitalist Brad Feld on topics ranging from financing strategies for start-ups to the nature of innovation to what makes a successful entrepreneurial ecosystem to managing work-life balance. Readers of Brad’s blog already appreciate that his insights and wit are not to be missed.

Entrepreneurs Unplugged with Glenn Jones
6:00pm at Wittemeyer Courtroom, Wolf Law Building
On April 15, 2009, the Silicon Flatirons Center will present Glenn Jones, one of the finest entrepreneurs to come out of CU Law and a cable industry pioneer, as our featured entrepreneur in our Entrepreneurs Unplugged series. Widely viewed as an important developer of the modern cable industry, Mr. Jones is also pioneering the development of distance education opportunities using the Internet.

Thursday, 4/16
Conference: Putting The Entrepreneurial Ecosystem in Perspective
3:00pm – 8:00pm, Wittemeyer Courtroom, Wolf Law Building
4 CLE credits available
Commentators, policymakers, and businesses often talk about an “entrepreneurial ecosystem.” The conception, however, remains undefined. In this conference, we will take a critical look at the idea of an entrepreneurial ecosystem, examining how it facilitates innovation. In particular, we will evaluate the ingredients that enable a local community to develop an entrepreneurial culture and reach a critical mass of inventive activity. Moreover, we will evaluate how entrepreneurs are able to recognize what inventions truly matter–i.e., are “disruptive” in the sense that they can make a big impact on an established market. In so doing, we will also ask what pitfalls there are along the way where firms seeking to take advantage of such opportunities either make the right or wrong strategic and tactical judgments.

The lineup for the 2009 conference, “Putting The Entrepreneurial Ecosystem in Perspective,” features, among others, Governor Bill Ritter and academic stand-outs Karl Ulrich (Wharton School of Business) and Anno Saxenian (University of California-Berkeley’s Information School). more…

Friday, 4/17
CU New Venture Challenge Semifinals, Finals and Post-Challenge Reception
The first annual cross campus business plan competition teams compete for cash and in-kind prizes before a panel of investors, entrepreneurs and professionals from the entrepreneurship community.
The semifinals will be held from 9 am – noon in various locations throughout the ATLAS building. Finals will begin at 2 pm in Room 235 at the University Memorial Center; reception and announcement of awards to follow at the UMC (weather permitting on the balcony of the UMC or in Room 235).

Again, lots more information about these events (and more) are over on the Silicon Flatirons site.

« view less

It seems like every year I see more and more companies that are trying to raise money and are structured as LLCs. It feels like lawyers across the country are recommending an LLC structure for early stage startups. But they’re not asking one important question: “Are you planning on raising professional investment?”

If there were, then there would be more companies avoiding the LLC structure and setting things up as Delaware S corporations that eventually drop their S elections and become C corps. If you are serious about raising money, my advice is usually not to set up an LLC. Set up a Delaware S or C corp.

Of course anything can be fixed, so it’s far from fatal if you do set up an LLC. You can set up a C corp and have it buy the assets of the LLC. It just costs money and time. You end up with less money and the lawyers end up with more.

Occasionally, angels will invest in LLCs, but it’s basically unheard of for VCs. TechStars is an interesting case – we greatly prefer to invest in S or C corporations, but we’ll also invest in LLCs only because it’s not practical to pay to dump the LLC and incorporate the company at a very early stage. But man, can it be a headache. Those LLCs all have to provide K-1s to their investors. This ends up happening at the last minute and delaying personal tax returns for those investors. This sounds like a small problem, but investors who play with LLCs end up spending a bunch of extra time running around at tax time. I’m particularly sensitive to it right now because it’s that time of year. There are other reasons investors don’t like LLCs too. One big example is that they may end up creating tax bills before generating any liquidity.

Bottom line: Assuming you’re not ready for a C corp, create your decision tree based on whether or not you feel that raising professional investment is desired/likely. If so, consider a Delaware S corp for now. This is very easy to change to a C corp. If you don’t plan to raise money, you can get away with an LLC and it may have very real tax advantages for you to do so. As always, consult your (ideally, venture experienced) accountant and/or legal counsel before taking any specific advice, especially from me.

As for why I’m suggesting Delaware, that’s for another post.

UPDATE: I posted More on LLCs two days later as a follow up.

« view less

The 21st Annual Colorado Capital Conference is looking for companies that would like to present to angel investors in Denver on May 12. To become a presenting company, you must be seeking either angel or VC funding to grow your business. The conference will select up to eight companies seeking angel financing and up to four companies looking for VC money.

If you’d like to submit your company for consideration, visit the conference website where you will find step-by-step instructions. Applications must be received by 5:00 p.m. on Tuesday, April 7th.

If you’re an investor, you can learn more about attending as well.

« view less

Slowly, quietly, but surely Alex Muse and I have been building a startup blog network called SpringStage. We’ve been in a live beta for about 3 months now. We have about 35 blogs on the network at this point and, like this one, they’re all focused on their local geography.

With a little prodding from Micah Baldwin, Alex and I got together last year to discuss this concept. Alex been writing the fantastic Texas Startup Blog for years, and I’d been writing Colorado Startups. We had both done this for the same reasons – to provide exposure for our respective communities, as well as to facilitate connections locally between investors and entrepreneurs. Independently, and without knowing each other, we both came to realize the tremendous and simple power of simply writing about what was going on in our startup communities.

Independently over several years, Alex and I had learned a great deal about how to become catalysts for our communities. Certainly we weren’t the only ones in our communities making these connections and providing this exposure, but we felt we were each making a difference in our own unique way. SpringStage was born to help others do this same thing in an organized manner.

We’ve now recruited dozens of new catalysts to cover their local startup communities, and it’s been amazing to watch these folks work to make their own part of the world a little better. We’re all sharing ideas and best practices. We’re just beginning to scratch the surface by tapping into national sponsors, coordinating national events, and more. Our ultimate goal is to make sure there’s a credible SpringStage catalyst covering every community in the world on our network. That way, if someone wants to know what’s going on in Abilene, TX, they can easily find out. We want to make sure it’s dead simple to find the best startup resources in any part of the world.

We’re also releasing a feature soon that geographically aggregates our blogs. This way, you’ll easily be able to subscribe to “the midwest”, the “USA”, “Texas” and other aggregated sets of blogs on the network.

SpringStage is one of those projects that Alex and I started simply because we felt that it should exist. So far, the response has been overwhelming. It’s been really encouraging to see new catalysts from all over the world suddenly take over our “popular posts” leader board by just creating great content that’s being shared and discussed.

Here are a few of my favorite recent posts from the network:

• Video coverage from The San Antonio Startup Blog of Blellow, a SXSW favorite from San Antonio, and other startups from there who were at SXSW.
• Coverage from North Carolina Startups on the interesting startup Shoeboxed.
• The Philadelphia Startup Blog covering Fwd:Vault, a simple backup service that work via email.
• The Caribbean even has startups – see their coverage of the Top 10 Facebook Marketing Resources for Caribbean brands.

Like I said, this has really been fun to watch. If you’d like, you can get a taste of startup activity from all over the world by adding the SpringStage global feed to your reader. Watch SpringStage.com for our regional feeds that are coming soon. And don’t forget about our search bar on SpringStage.com, which now lets you search dozens of startup blogs at once.

Finally, SpringStage provides some neat opportunities for advertisers as well. You can run ads across our entire network, or target them by any local geography. And our startup job board which is already very popular in Texas and Colorado is now going worldwide. This is the cheapest (just $5.00!), most targeted way to reach talent that wants to be a part of your startup, while still getting your ad onto the entire SimplyHired network.

I hope that you’ll spread the word about SpringStage and encourage all of our new catalysts to keep their good work up. If you know someone who’s into the startup scene in one of these geographies (see “Networked blogs” in right hand column), please forward them this post and ask them to check it out. Likewise, if you know someone who might like to join the network as a Catalyst and blogger, please let them know where they can find us.

I really hope you enjoy the SpringStage Startup blog network. It’s been a bit of a labor of love and I’m excited to see it continue to grow.

« view less

The application deadline for TechStars is this Saturday, March 21. The program is running in Boulder as always, and we’re added a Boston program this summer as well. That’s twice the opportunity for early stage startups to get this intensive mentorship opportunity. We’re taking about ten companies in both cities, for a total of about twenty companies this year.

Please forward this blog post on to some interesting early stage startups that you think might benefit from this opportunity. It’s their last chance to apply for 2009!

« view less