On the Tax Efficiency of Startup Firms

We examine the choice of organizational structure for VC-backed startup firms. These firms overwhelmingly organize as C-corporations rather than as tax advantaged limited liability companies (LLCs). This results in foregone tax savings of $43.9 billion, or 4.9% of the total equity invested in the sample firms. The decision is puzzling given plausible estimates of the direct costs involved, but appears related to ‘hassle,’ and other transition costs generated by participants implementing a new form. Firms with more employees and investors are likely to choose the C-corporation. VCs appear to prefer the C-corporation form, as receiving VC money is associated with most LLC firms switching to a C-corporation within 30 days. Greater VC preferences for C-corporations are linked to a preference for familiarity, and less attention to taxes.

Keywords: Venture Capital, Startups, Tax, Behavioral Finance, CEOs

JEL Classification: G24, G32, H26

Suggested Citation: Suggested Citation

Allen, Eric J. and Allen, Jeffrey and Raghavan, Sharat and Solomon, David H., On the Tax Efficiency of Startup Firms (August 11, 2021). Review of Accounting Studies, forthcoming, Available at SSRN: https://ssrn.com/abstract=3069256 or http://dx.doi.org/10.2139/ssrn.3069256