The Impact of Non-Tax Costs on the Tax-Efficiency of Venture Capital Investments

42 Pages Posted: 11 Feb 2011 Last revised: 16 Apr 2013

Eric J. Allen

University of Southern California - Leventhal School of Accounting

Sharat Raghavan

University of California, Berkeley - Haas School of Business

Date Written: July 26, 2011

Abstract

Current practice dictates that loss-generating startup firms organize as C corporations rather than the theoretically more tax efficient alternative—the limited liability company. We measure the cost of this divergence between theory and practice and find that 83.32% of our sample of 1,067 startup firms that conduct an IPO report accumulated tax losses of $31.96 billion at issuance. The losses are estimated to represent foregone tax benefits with a present value from $1.4 billion to $4.4 billion, depending on the type of investor assumed to utilize them. This is the first quantification of the tax benefits foregone by the current organizational structure and represents a lower bound estimate of the non-tax costs market participants assign to switching to the limited liability company (LLC). We also investigate the distinguishing characteristics of the 19 firms in our sample that receive venture capital funding and remain LLCs until IPO. These firms are generally more profitable and less reliant on venture capital than those that organize as C corporations.

Keywords: Limited Liability Company, Venture Capital, Loss Firms, Organization Choice

JEL Classification: M40

Suggested Citation

Allen, Eric J. and Raghavan, Sharat, The Impact of Non-Tax Costs on the Tax-Efficiency of Venture Capital Investments (July 26, 2011). 2011 American Taxation Association Midyear Meeting Paper: JLTR Conference. Available at SSRN: https://ssrn.com/abstract=1759558 or http://dx.doi.org/10.2139/ssrn.1759558

Eric J. Allen (Contact Author)

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

Sharat Raghavan

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

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