Why Do VC Firms Prefer C Corporations?
If you're building a startup with dreams of raising venture capital, you’ve probably heard that VCs prefer C corporations. But why is that the case?
While every startup is different, there are a handful of compelling reasons why C corporations especially those formed in Delaware are the default choice for venture-backed companies. Here’s a breakdown of why this structure is so attractive to venture capital firms.
1. Tax Simplicity and Entity Level Taxation
One of the main reasons VCs prefer C corporations is tax treatment. Unlike LLCs and S corporations, which use pass through taxation (where profits flow directly to the owners), C corporations pay taxes at the entity level.
This matters to VCs, particularly those with tax exempt partners (like university endowments or pension funds), who don’t want to be exposed to “unrelated business taxable income”(UBTI). C corporations isolate the tax liability within the company itself, making it cleaner for investors.
2. Preferred Stock and Investment Structure
VCs love preferred stock and C corporations are the only structure that easily supports it.
- LLCs don’t issue stock at all. They use membership interests, which can be structured with preferences, but doing so is complex and expensive.
- S corporations are legally prohibited from issuing more than one class of stock so preferred shares are off the table.
Preferred stock gives VCs enhanced control, priority on dividends and liquidation, and protections in the event of down rounds or other major corporate events. C corporations make this possible without legal gymnastics.
3. Attracting and Retaining Talent
Equity compensation is a key strategy for startups to attract top talent. C corporations allow you to issue stock options specifically Incentive Stock Options (ISOs) which come with favorable tax treatment for employees.
In contrast:
- LLCs can’t issue stock options. They can offer “profits interests,” but these are legally complex and less familiar to most employees.
- S corporations face shareholder eligibility restrictions and other limitations that make issuing equity more difficult.
For high-growth startups competing for talent, the flexibility of a C corporation is a big win.
4. Smoother Exit Opportunities
When it comes time to sell the company or go public, C corporations offer the cleanest path:
- C Corp shares are generally freely transferable, making M&A transactions easier.
- LLC and S Corp ownership interests come with transfer restrictions, making deals more complicated or unattractive to buyers.
VCs invest with an eventual exit in mind so anything that facilitates a clean and profitable exit is a major plus.
5. QSBS: The Ultimate Tax Break
One of the biggest hidden advantages of a C corporation? Qualified Small Business Stock (QSBS).
QSBS allows founders and investors to pay zero federal capital gains tax on up to $10 million (or 10x their investment, whichever is greater) if they hold their shares for five years. That tax break can grow to $500 million if managed properly.
Imagine this:
You start your company as a C Corp, issue yourself founder shares, and five years later, you sell your startup for $10 million.
You pay $0 in federal capital gains tax. That’s an enormous benefit and one that LLCs or S corporations don’t qualify for.
You can technically convert an LLC to a C corporation before hitting $50M in assets and still qualify for QSBS but doing so incorrectly could wipe out your eligibility. That’s why many start ups start out as C corporations from day one.
6. Familiarity and Legal Infrastructure
Finally, VCs like what they know and what they know is Delaware C corporations.
Delaware has a well established legal framework, robust case law, and a business friendly court system. Incorporating in Delaware gives investors confidence that they’re operating in a familiar and predictable environment.
Conclusion: It’s About Growth, Investment, and Simplicity
C corporations aren’t perfect for every business. If you're running a lifestyle business or have no plans to raise VC money, an LLC or S corporation might make more sense in the early stages.
But if raising capital is part of your startup journey, structuring as a C corporation especially from the beginning can eliminate future headaches, streamline legal and tax processes, and unlock powerful tax advantages like QSBS.
Planning ahead is key. Work with legal and tax professionals early to choose the best structure for your business’s current needs and future goals. And if you’re not ready for a C Corp today, remember: you can convert later but timing and execution are everything.