On the Tax Efficiency of Startup Firms

54 Pages Posted: 14 Nov 2017 Last revised: 30 Aug 2018

See all articles by Eric J. Allen

Eric J. Allen

University of Southern California - Leventhal School of Accounting

Jeffrey C. Allen

Bentley University

Sharat Raghavan

University of California, Berkeley - Haas School of Business

David H. Solomon

Boston College - Carroll School of Management

Date Written: March 1, 2018

Abstract

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 $44.4 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 the cost of participants learning about the unfamiliar 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 in firm geography, and lower likelihood of the VC discussing taxes on their website.

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

JEL Classification: G24, G32, H26

Suggested Citation

Allen, Eric J. and Allen, Jeffrey and Raghavan, Sharat and Solomon, David H., On the Tax Efficiency of Startup Firms (March 1, 2018). Available at SSRN: https://ssrn.com/abstract=3069256 or http://dx.doi.org/10.2139/ssrn.3069256

Eric J. Allen (Contact Author)

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

Los Angeles, CA 90089-0441
United States

Jeffrey Allen

Bentley University ( email )

175 Forest Street
Waltham, MA 02145
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

David H. Solomon

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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