Raising capital and obtaining necessary funding to support business growth has always been a challenge for startup entrepreneurs, especially those requiring large up-front capital resources.
For businesses that particularly hope to win an investment from Venture Capital firms, a Delaware C corporation is an ideal entity structure to start with.
In today’s articles, we will get into the specifics of why Delaware C-corps are great options for Venture Capital fundraising and how you can incorporate one.
1. What does venture capital actually 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.
Unlike other financing firms that provide funding as a loan which must be paid back often with interest, VC offers funding to startups in exchange for equity and requires no pay-back obligations.
Aside from the infusion of cash, VCl can also offer numerous benefits for startups, such as:
- Business expertise – Obtaining VC funds can provide a start-up with valuable sources of guidance, which contributes to the company's decision-making and management process.
- Hands-on support – VC firms can offer active support in a number of 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.
2. 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 capitalist 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. Some notable characteristics of this business structure in relation to VC fundraising include:
- Limited liability
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 in relation to debts and litigation, which separates them from any risk of business negligence.
- Tax implications
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.
- Preferred stock
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.
- Legal flexibility
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.
3. 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 attorneys’ fees) and time. For this reason, it is considered beneficial for startups to incorporate a Delaware C-corp at the formation stage.
Below are key steps to set up a Delaware C corporation:
- Choosing corporation’s name as per Delaware law;
- Appointing a registered agent
- Filing Certificate of Incorporation
- Preparing corporate bylaws
- Appointing directors and holding Board Meeting
- Issuing stock
- Submitting annual report and franchise tax
- Obtaining an EIN
Phase 2: Preparing for VC investment
- Protect your Intellectual Property (IP)
If your business possesses any types of intellectual properties (patents, trademarks, copyrights, etc.), make sure these IPs are secured and registered 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, it is crucial that a startup develops a solid pitch deck that conveys a compelling, interesting story to attract investors.
Phase 3: Keeping track after VC fundraising
By the time a business gets funding from VC, it will go through certain changes. It is crucial that business owners take full notice of the following issues and react accordingly.
- Legal compliance
If you are able to 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.
Feel free to contact us with any questions you may have.