Fundraising and Investor Considerations: Choosing the Right Entity for Business Growth
In our earlier article, Choosing the Right Business Entity: A Comprehensive Guide to Setting Your Business Up for Success, we explored the foundational aspects of selecting a legal entity for your business. Today, we take a deeper dive into how your choice of entity specifically impacts your ability to raise funds and attract investors—a critical factor for startups and growth-oriented businesses.
Your entity type plays a pivotal role in shaping investor confidence, determining your fundraising avenues, and even influencing your scalability. By understanding how each entity aligns with investor expectations and business goals, you can make an informed decision that sets your venture on a path to success.
1. How Entity Choice Influences Fundraising
Your choice of entity affects:
Investor Pool: Restrictions on ownership or equity offerings can limit your ability to attract certain types of investors.
Tax Implications: Tax structures of different entities influence returns for investors and the financial health of your business.
Capital Structures: Some entities allow for more sophisticated financing options, such as issuing multiple classes of stock.
Scalability and Exit Strategy: Certain entities are better suited for IPOs, acquisitions, or other exit strategies.
To succeed in fundraising, your entity must align with the needs of both your business and your target investors.
2. Revisiting Entity Types: A Fundraising Perspective
Let’s revisit the entity types discussed in our earlier article, this time through the lens of fundraising and investor considerations.
Sole Proprietorship
Fundraising Impact: Sole proprietors face significant challenges in attracting external funding. Without the ability to issue stock or equity, fundraising relies on personal resources, loans, or grants.
Best For: Micro-businesses with minimal capital needs.
General Partnership
Fundraising Impact: Partners pool resources, but external fundraising is limited. The lack of liability protection for partners can deter investors.
Best For: Small teams of entrepreneurs with aligned goals and low capital requirements.
Limited Liability Company (LLC)
Fundraising Impact: LLCs offer flexibility for small to medium-sized businesses seeking private funding. Investors can receive membership interests, and there are no restrictions on ownership types.
Challenges:
Institutional investors and venture capital (VC) firms often prefer corporations due to the complexities of LLC membership structures.
Conversion to a C Corporation may be necessary for larger fundraising rounds.
Best For: Early-stage businesses or those with a smaller, private investor pool.
S Corporation (S Corp)
Fundraising Impact: The ability to offer equity is limited by strict ownership restrictions:
Maximum of 100 shareholders.
Shareholders must be U.S. citizens or residents.
Challenges: These restrictions make S Corps less attractive to institutional investors and unsuitable for scaling rapidly.
Best For: Closely held businesses or family-owned companies with predictable, modest fundraising needs.
C Corporation (C Corp)
Fundraising Impact: C Corporations are the gold standard for businesses seeking significant funding. They allow:
Issuance of multiple classes of stock, including preferred stock with investor-specific benefits.
Unrestricted ownership, enabling global and institutional investments.
Challenges:
Double taxation on corporate profits and shareholder dividends.
Increased regulatory and compliance requirements.
Best For: High-growth startups, businesses seeking venture capital, or companies preparing for an IPO.
Nonprofit Corporation
Fundraising Impact: Nonprofits rely on grants, donations, and tax-exempt funding rather than traditional investment.
Challenges:
Limited to activities aligned with charitable or educational missions.
No equity offerings for investors seeking financial returns.
Best For: Organizations with philanthropic or mission-driven goals.
3. Key Fundraising Considerations for Entity Selection
Investor Preferences
Institutional investors and VCs favor C Corporations for their scalability, flexibility, and clear governance structures. The ability to issue preferred stock with features like liquidation preferences and anti-dilution rights is a major draw.
Ownership Flexibility
Entities like LLCs and S Corps impose limitations that can deter potential investors. S Corps, for example, restrict ownership to individuals and limit the number of shareholders, excluding many institutional players.
Tax Efficiency
Pass-through entities like LLCs and S Corps allow investors to avoid double taxation, but this advantage may be outweighed by the structural benefits of a C Corporation for larger investments.
Exit Strategies
C Corporations provide the clearest pathway for exits such as IPOs or acquisitions, making them attractive to investors who prioritize liquidity and returns. LLCs may require restructuring to prepare for an exit, creating additional costs and complexity.
4. Aligning Entity Choice with Fundraising Goals
Startups Seeking Venture Capital
C Corporations are often the default choice for startups aiming to secure VC funding. The ability to offer equity incentives, accommodate multiple rounds of funding, and support complex capital structures makes this entity type ideal.
Bootstrapped or Privately Funded Businesses
LLCs can be a good fit for businesses relying on private investors or bootstrapped growth. The flexibility in ownership and tax benefits can offset the challenges of limited scalability.
Small Family-Owned Ventures
S Corporations work well for businesses that plan to raise funds within a close-knit group of shareholders. The tax advantages and liability protection can provide a solid foundation for smaller operations.
Mission-Driven Organizations
Nonprofit corporations excel at raising funds through donations and grants. However, their inability to offer equity makes them unsuitable for investors seeking financial returns.
5. Building a Scalable Foundation
As we highlighted in our earlier article, entity selection isn’t a one-size-fits-all decision. Businesses must consider both their immediate needs and long-term goals when choosing an entity. Fundraising adds an additional layer of complexity, requiring alignment between your business structure and investor expectations.
If you’re unsure how to align your entity with your fundraising strategy, consult with legal and tax professionals who can provide tailored advice.
6. Partner with Lazarus for Expert Guidance
At Lazarus, we specialize in helping entrepreneurs and businesses navigate the complexities of entity selection and fundraising. Whether you’re launching a startup, preparing for a funding round, or considering a restructuring, our team offers strategic legal counsel to position your business for success.
For a deeper dive into choosing the right entity, read our foundational article, Choosing the Right Business Entity: A Comprehensive Guide to Setting Your Business Up for Success, and contact us to schedule a consultation tailored to your needs.
Conclusion
Choosing the right entity type is critical to your fundraising success. By considering investor expectations, tax implications, and long-term growth strategies, you can create a solid foundation for attracting capital and scaling your business. Ready to set your business up for success? Let Lazarus guide you every step of the way.