Thank you for writing this. It's incredibly important and basically no one talks about it.

I can only reiterate what you've said: - Selling your company in an asset sale as a C-Corp increases your taxes 20-30% or more - Unless you're a BFD and have tons of inbound acquisition interest, the acquirer is going to dictate whether it's a stock sale or an asset sale, and they will almost always want an asset sale (less liability for them) - You should only be a C-Corp in the first place if you're a venture backed startup. Start with an LLC and just do a conversion to a C-Corp when you raise money; this maximizes your optionality.

One of our early investors insisted we transition to a C-Corp "for tax purposes". We were later acquired via an asset sale. The acquirer refused to do a stock deal. We ended up paying an effective 61% tax rate federal+state on the exit. I really wish we would have stayed an LLC.

However, all of Gust's points are valid if you successfully negotiate a stock sale.

Start a company today, and if you're lucky, you'll sell it no sooner than 5 years. In that case, you'll most likely qualify for QSBS, which means you'll pay an effective rate of 0%. Only available for C-Corps. You're welcome.

To expand on this as it's an important point and QSBS is the reason why VCs love C Corps... the deduction is the a HUGE benefit but also thanks to our tax system the deduction % is not static...

The % deduction you can take is entirely dependent on the year and sometimes month of when your stock is issued. For example we had C Corp stock issued in February 2010 so our FEDERAL deduction was 75% NOT 100% which it would have been if it was issued in November of the same year (Blah), also California no longer has the QSBS deduction so you still pay the 8%+ here.

After reading all the comments about C Corp vs. LLC, I am thinking to start my business as LLC and when the time comes that business is on the right track and I have investors willing to invest, convert the LLC to C Corp at that point.

I live in New Jersey. My startup is e-commerce business which will deliver goods to anywhere in US. And initially I will not need any physical office - I will run my business from my home. It will require for me to ship goods from my garage, but I will not have employees or office until at least a year, if the business succeeds.

My questions: 1) Do I need to establish my startup in Delaware or is it enough to just register it as LLC in New Jersey? 2) If some of you say I should register in Delaware, then my question becomes do I need to register NJ as foreign qualification as well? Or is that ok to just have Delaware only until I need an office space and have employees in NJ - only at that time establish foreign qualification in NJ.

I have made some research but not clear to me if it is safer to establish the NJ LLC as foreign qualification (in case I am recommended to establish the business in Delaware) even if I run the business initially from home but provide my service to customers across US.

I appreciate any advise.

Dumb question, but why not sell the asset to a newly formed corporation without the liability issues, then sell that corporation?

Conversion is treated as a taxable event. If you claim the IP is worth $0 but sell it two days later for $10M, you're going to have problems.

So, if I own a corporation that buys an asset for $500,000, then I turn around and sell the corporation for $10,000,000, I'm in some kind of hot water?

Depends. If the asset is digital, you can register the corporation in a tax haven through a offshore broker (Cayman, Panama, or St. Kitts), acquire the asset and then turn around and sell the corporation.

You can always "sell a corporation." It is not necessary to go to a tax haven.

I think you missed my point, which was that if I own a corporation and it buys an asset, then I sell that corporation, are these things tied together?

If the corporation simply found a deal, then the owners of the corporation chose to sell, why would the corporation (or owners) get hit with a gain on asset (purchased by corporation) tax? The shareholders should be taxed as normal gain on assets (shares) and it should not be reflected in the taxes paid by the corporation, unless I am missing something.

Why don't US companies just employ a 'double Irish' on all their IP?

Edit: I mean from inception/company formation. Wouldn't that save you all the aforementioned headaches? Especially when the time comes for an exit to happen.

Hi, this is David S. Rose, CEO of Gust. Thanks for all these interesting comments. The reason we don’t spend time talking about selling a C corp is because pragmatically it is irrelevant to what we’re doing. Gust Launch is designed for a very specific type of company that makes up a small subset (in fact, less than 10%) of all new businesses. We designed it to handle the specialized case of a startup that is being established from the very beginning to be a scalable, high-growth venture (the kind of company my book ‘The Startup Checklist’ was written for.) This type of business is founded with the intention of raising funds from outside investors such as angels or VCs, the intention of providing most (or all) employees with equity in addition to cash compensation, and the intention of exiting through either an M&A transaction or an IPO within five to ten years.

For many (if not most) other types of businesses, particularly companies that are going to remain as small- to mid-size, cash generating, businesses that will not require a lot of capital investment, incorporating as an LLC in their home state makes a lot of sense. But for the high-growth startup seeking investor funding, incorporating as a Delaware C corporation is without any question whatsoever the most appropriate, least expensive and most standard way to incorporate.

There certainly are tax differences in the treatment of an asset sale compared to a stock sale. But for the kinds of startups that should be using Gust Launch, that is invariably not an issue, because for those businesses an asset sale generally means a bad exit. In fact, in my entire investing and entrepreneurial career, spanning literally hundreds of companies over two decades, I have never once seen a positive M&A scenario in which the acquirer demanded an asset sale. Instead, most target companies forced into asset sales are being sold for less than their basis and less than the liquidation preference or convertible note balance, so the question of tax on asset gains or liquidation distribution simply does not apply.

@GoRudy is correct that in the subset of acquisitions where there is a gain for the target company, it is highly disadvantageous for the target company's shareholders to structure the transaction as an asset purchase. Realistically, they would be getting a lousy deal, but that would have been caused either by the company not being worth much, not negotiating well, or because it has incurred some troublesome contingent liabilities.

The few times I've seen asset purchases with unfavorable tax treatment, the CEO had signed the highest dollar term sheet offer (or the only available one), and they were either oblivious to the tax implications or else the acquirer did not even mention the form of transaction until starting to negotiate the definitive documents. Companies in that position should absolutely negotiate hard for a stock acquisition, a higher price, or carefully work out some other more advantageous tax structure.

But ultimately there's a more general point to be made here. Startups—and the investors who fund them—optimize for growth and financial upside, not to limit downside or engage in complex tax planning that would limit opportunities.

If you create an LLC structure that generates 20% higher after-tax proceeds in the case of an early exit, but substantially lower proceeds in a successful exit because of (1) the Qualified Small Business tax deduction being unavailable, (2) the requirement to make tax distributions and pay income tax along the way, and (3) making the company generally unfundable, you're setting your company up for failure, not success. Put another way, if you knew at the start that your company were heading for an asset sale, you probably shouldn't be doing it in the first place, and for sure no one else should be investing in it.

We—and the majority of people who work with successful startups—have a similar attitude towards starting a business as an LLC and then reincorporating as a C corporation—at a cost of many thousands of dollars—only if and when the company shows promise. That's like refusing to quit your day job until you know your company will succeed. It's understandable, and might even make sense in some cases, but it limits your odds of success and is telegraphing that you are accepting defeat before even getting started.

[BTW, for those founders concerned about double taxation during the early days of a startup, there’s a way to have your cake and eat it too: incorporate as a Delaware corporation and file a “Sub-chapter S” election with the IRS. That will give you all the benefits of the corporate structure (other than QSB eligibility) but also provide the one level of taxation/pass-through treatment that you would get with an LLC. Note that the requirements for sub-S election are: one class of stock (ie, no investors with Convertible Preferred), only individuals as stockholders (no LLCs, corporates or investment SPVs), and only US-based stockholders.]

It seems a great pity that the US doesn't have a dividend imputation system.