Delaware C-corp, LLC or California corporation?

What investors usually look for

Venture financings are typically structured as preferred stock. Under Delaware law, a corporation may issue one or more classes or series of stock, each with its own voting powers, preferences and restrictions, as set out in the certificate of incorporation or in a board resolution the certificate authorizes. That flexibility, and a body of corporate law investors know well, is why many US startups form a Delaware corporation.

Tax status matters too. An LLC with two or more members is classified as a partnership for federal tax purposes unless it elects otherwise, so profits and losses flow through to the members. A corporation is taxed separately. The federal exclusion for qualified small business stock under section 1202 is available only for stock in a C corporation, and only if many other conditions are met. Ask a tax adviser before choosing an LLC for a company you expect to fund with venture capital.

Delaware does not take you out of California

A Delaware corporation that transacts intrastate business in California must register with the California Secretary of State before doing so. The usual filing is a Statement and Designation by Foreign Corporation, submitted with a current certificate of good standing from Delaware. California defines transacting intrastate business as entering into repeated and successive transactions of the company's business in the state.

Example: Two founders in Oakland form a Delaware corporation and start hiring in California. They now have two sets of obligations: Delaware's annual report and franchise tax, due on or before March 1 each year, and California registration, tax filings and employment law. The Franchise Tax Board says corporations incorporated, registered or doing business in California generally owe at least the minimum franchise tax, with a first-year exception for newly incorporated or qualified corporations.

When a California corporation or an LLC may fit

A California corporation avoids running two states' corporate filings, and it can still issue different classes of stock. Some founders who do not plan to raise venture capital, or who want to keep things simple at first, start this way. Converting or reincorporating later is possible but takes time and documents, so the choice is worth thinking through early.

An LLC can suit a services business, a joint venture, or a company that wants pass-through taxation and does not expect a priced equity round. Check the operating agreement carefully: it sets voting, transfers, capital accounts and what happens when a member leaves, and it can be more customized than a corporation's standard documents.

Your next steps

1. Decide whether you expect to raise priced venture rounds before choosing the entity.
2. Get tax advice on LLC versus C corporation status, including section 1202.
3. If you form in Delaware and work in California, register in California before transacting business there.