New Venture Lab: Equipping Christian Entrepreneurs

Question

I am thinking about raising equity and granting stock options, but I am currently organized as an LLC.  Any thoughts on that?

Answer

Typically an institutional investor such as a venture capital or private equity investor will only invest in a C corp (and a Delaware C corp at that.)  Since an LLC is more of a partnership type of entity (see here and here for more on entities), most institutional investors will not have the "distance" they want from their portfolio companies in term of legal entanglements.  Also, they tend to get to know the laws and practices of Delaward C corps and can therefore operate much easier since they get to know such obsure things such as when a board resolution is required vs. a shareholder vote or what a typical shareholder rights agreement contains vs. what document to look in to find the anti-dilution clause, etc.

In terms of issue options, it is typically fairly difficult to grant stock options in an LLC, S corp or other partnership interest type of entity structure.  The only thing I''ve issued for incentives in an LLC is either a shadow stock program or a value sharing agreement.

One CPA firm website answers the "options in an LLC" issue as follows:

Q: Can an LLC issue options?

A: LLC’s do not have an exact equivalent of incentive stock options.

However, an LLC can:

• Grant options to purchase LLC units to employees, this has similar tax consequences as granting non-qualified stock options;
• Create a corporate member of an LLC and have that corporate member form a stock option plan and issue stock options to employees of the LLC;
• Create a management LLC entity which becomes a member of the operating LLC, then allocate or grant interests in the management LLC to the employees of the operating LLC; and/or
• Form a phantom type equity plan.

Source: HA&W