On the Tax Efficiency of Startup Firms
54 Pages Posted: 14 Nov 2017 Last revised: 30 Aug 2018
Date Written: March 1, 2018
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: Suggested Citation