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What does venture capital do for Delaware startups?
There are lots of different methods to finance a new business such as personal investment, bank loans, crowdfunding, etc. But Venture Capital (VC) is considered one of the most powerful funding options that help startups to scale up quickly and reach their full potential.
While other financing firms provide funding as a loan, VC offers funding in exchange for equity, with no pay-back obligations.
Aside from the infusion of cash, VC can also offer numerous benefits for startups, such as:
- Business expertise – Obtaining VC funds can provide a start-up with valuable sources of guidance. This contributes to the company’s decision-making and management process.
- Hands-on support – VC firms can offer active support in several key areas such as legal and taxation that ensure business sustainable growth and development.
- Connections – VC firms are well connected in the business community which allows businesses to access useful networks and build strong connections that will come in handy across the lifespan of the company.
Why incorporate a Delaware C corporation for VC fundraising?
Despite its advantages and benefits for startups, VC fundraising is not for every business to obtain.
It is important to know that venture capitalists typically focus their investment efforts on specific business structures, one of which is Delaware C corporation.
Delaware C corp has favorable business features that make it a preferred structure for VC to invest.
For a great idea of how this company type could help you achieve your business ambition, just read our article Top 4 Delaware Corporation Benefits You Should Know
Some notable characteristics of this business structure of VC fundraising include:
One of the most appealing advantages of a Delaware C corp to VC investors is its strong capability in terms of liability protection.
By investing in a C corporation, the venture capitalists will automatically have limited liability concerning debts and litigation, which separates them from any risk of business negligence.
C corporations are taxed at both corporate and individual levels. And such double taxation is regarded as the biggest drawback of C corporations in most cases.
However, most VC investors do not expect their investments to produce profits or income in the early years, and perhaps even beyond. Therefore, the threat of double taxation is not a significant factor as investors are only taxed if the company earns income.
In addition, C corporations pay very low taxes on retained earnings (the percentage of net earnings retained to be reinvested into the company), so the profits not paid out as dividends can be utilized to spur the company’s growth, which lessens the tax burden imposed on VC investors.
The majority of VC investors favor C corporations because C corporations are allowed to issue preferred stocks (or preferred shares).
This class of stock may grant special levels of preferences, protections, and share valuations. Other business structures such as LLCs or S-Corps cannot create “preferred shares” for investors.
VCs will specifically demand preferred stock in return for their significant investment.
It provides them with more privileges than common stockholders, such as liquidation preferences, rights to board seats, and rights to maintain ownership percentage in future financing rounds, which help reduce the risks of funding a start-up.
C corporations provide VC firms with the most legal flexibility when it comes to investing.
For example, venture capitalists cannot invest in S corporations since S corp is subject to strict eligibility rules that prohibit ownership by anyone other than individuals, descendants’ estates, bankruptcy estates, certain types of trusts, or charitable organizations. VC funds do not meet these eligibility requirements.
Therefore, by investing in C corporations, VC firms can avoid numerous legal entanglements and complications.
Business framework familiarity
VC investors feel more comfortable with the well-known, business-friendly legal framework of Delaware C-corps.
Accordingly, capital investors prefer to work with the laws and procedures regarding this type of entity.
Familiarity with business frameworks can streamline financial and legal procedures, which increases the efficiency of the fundraising process.
Forming a C corporation in Delaware for VC fundraising
To successfully get investment from venture capitalists, businesses need to go through 3 main phases, including:
Phase 1: Incorporating your Delaware C corp
Not all is lost if you choose to incorporate other types of entities, as it is still possible to convert to Delaware C-corp later on, if necessary.
However, the re-incorporation process can be costly in terms of finances (e.g., additional filing and attorney’s fees) and time. For this reason, it is beneficial for startups to incorporate a Delaware C-corp at the formation stage.
Below are key steps to register a Delaware C corporation:
- Choosing the corporation’s name as per Delaware law;
- Appointing a registered agent
- Filing Certificate of Incorporation
- Preparing corporate bylaws
- Appointing directors and holding Board Meetings
- Issuing stock
- Submitting annual report and franchise tax
- Obtaining an EIN
All-in-one guideline to business formation in Delaware
- Explore Delaware business entities
- Discover incorporation process
- Understand Delaware tax system
- Learn about banking issues and other considerations
Phase 2: Preparing for VC investment
- Protect your Intellectual Property (IP)
If your business possesses any type of intellectual property (patents, trademarks, copyrights, etc.), make sure you secure and register these IPs before looking for investors.
For some companies, IP can generate significant value and help establish and maintain a company’s standing within its particular field.
As such, VC investors normally prefer to invest in companies that properly protect their proprietary value to avoid any potential lawsuits or financial loss.
- Create a pitch deck
The key method to successfully secure VC funding is to develop a solid pitch deck.
Most VC firms are very strict when it comes to evaluating potential businesses to invest in. Therefore, a startup must develop a solid pitch deck that conveys a compelling, interesting story to attract investors.
Phase 3: Keeping track of VC fundraising
By the time a business gets funding from VC, it will go through certain changes. Business owners must take full notice of the following issues and react accordingly.
- Legal compliance
If you can make the final deal with VC investors, there will be a ton of complex legal paperwork to complete.
Make sure you get support from a skilled legal advisor for this matter.
- VC fundraising timeline
The ultimate goal of VC investors is to sell a company to a bigger one or to position it for an IPO (Initial public offering).
The target date for a sale is usually within 10 years, and some VCs prefer to sell even sooner.
This could put pressure on businesses to accelerate growth, especially for those with a slow-and-steady development approach.
For the best results, business owners should match their business milestones to the typical VC timeline.
- Venture Capital is a great option for Delaware startups that are looking to scale up and grow sustainably,
- Venture Capital investors particularly prefer investing in Delaware C corporation for its advantageous business characteristics.
- Startup founders who hope to win investments from Venture Capital to get their business off the ground should form their companies as Delaware C corporations.
Disclaimer: While BBCIncorp strives to make the information on this website as timely and accurate as possible, the information itself is for reference purposes only. You should not substitute the information provided in this article for competent legal advice. Feel free to contact BBCIncorp’s customer services for advice on your specific cases.
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