If your startup began life as an LLC, you’re not alone. A lot of founders are told that starting as an LLC is “easier” or “cheaper.” That might be true on paper, but if you’re planning to raise venture capital (even eventually) it’s usually better to start as a C-Corporation.
Here’s one reason why: converting from an LLC to a C-Corp during a financing round can trigger a surprise tax bill if you’re not careful.
When a company converts from an LLC to a C-Corp and the founders contribute their ownership interests to the new corporation, they typically rely on Section 351 of the tax code to avoid recognizing gain. It’s a handy rule that lets you defer taxes if you contribute property (like your LLC interest) to a corporation in exchange for stock—as long as the original LLC owners (pre-conversion) own 80% of the company right after the exchange.
But that’s where it can get messy.
Let’s say you’re entering a financing round and you:
- Convert the company from an LLC to a C-Corp,
- Sell 20% of the company to a new investor, and
- Convert some outstanding SAFEs or convertible notes into equity—all at the same time.
If the new investor plus the noteholders take more than 20% of the company in the process, the original LLC owners (a.k.a. the founding team) might fall below the 80% ownership threshold. That means Section 351 no longer applies, and suddenly you have a taxable event on your hands. Not exactly the celebration you were expecting when you closed your round.
Bottom line: If your startup has any realistic plan to raise venture funding, it’s worth starting out as a C-Corp from day one. And if you’re already an LLC, talk to your lawyer and CPA before you convert, especially if you’re combining that conversion with a financing. The timing and structure matter more than you think.
Thanks for reading.