Why It's Easier To Raise Capital As An LLC Owner

Limited Liability Companies (LLCs) are an excellent business structure for fundraising and attracting capital. And why not? LLCs offer distinct advantages that surpass other business entities.

Their flexible management structures, reduced regulatory burdens, and customizable profit-sharing options provide a competitive edge that appeals to investors, particularly venture capitalists and private equity firms.

Unlike corporations, which are often entangled in rigid governance and double taxation, LLCs offer the agility to adapt management and financial structures to align with the business and its investors.

This flexibility simplifies bringing in capital and enhances the potential for higher after-tax returns. This makes LLCs an exceptionally powerful vehicle for your businesses if your goal is rapid growth and long-term success.

By maximizing your LLC, you can effectively secure the investment needed to fuel your ambitions and position yourself for a competitive advantage in the marketplace.

Flexibility of LLC Structure

The flexibility of an LLC is one of its most appealing features when it comes to attracting investors and lenders. LLCs offer more management freedom than other business entities (corporations) with rigid management requirements. This flexibility can be a significant advantage when you're trying to raise capital.

LLCs can choose how the company will be run: by its members (the owners) or by appointed managers.

This choice allows the business to tailor its management style to best suit its needs. For example, member management might be the best option in a small LLC where the owners are actively involved.

Bringing in professional managers in larger or more complex LLCs could be more effective. This flexibility shows that the business can adapt its management structure as it grows or as market conditions change.

LLCs can operate without a board of directors or corporate officers.

In a corporation, decisions must go through a board, which can slow down the process. In contrast, LLCs can make decisions more quickly because they don't have to go through these formal channels.

This can be particularly appealing in fast-moving industries where acting quickly can make a big difference. The ability to make quick decisions can be a major selling point when you're trying to secure funding.

LLCs have fewer record-keeping requirements and formalities than corporations.

That's less paperwork--a relief to business owners and potential investors alike. When investors see that the business is not bogged down by unnecessary red tape, they may be more inclined to invest.

LLCs allow for more customized agreements between members and investors.

The LLC operating agreement can be tailored to fit the specific needs and goals of the business. This includes how profits and losses are distributed, how decisions are made, and what happens if a member leaves the company.

Pass-Through Taxation and Its Appeal

One of the most significant benefits of forming an LLC is the option for pass-through taxation. Pass-through taxation isn't just beneficial when you pay taxes. It can be a major selling point and make your business highly attractive to potential investors.

After all, who wants to pay the IRS more than they need to? You probably don’t, and investors don’t either.

A note about pass-through taxation: an LLC itself is considered a passthrough entity. This means it does not pay federal income taxes. Instead, profits (or losses) are passed directly to the owners, known as members. These profits are then reported on the members’ individual tax returns.

Corporations are taxed on earnings, and then shareholders are taxed again on any dividends they receive. This double taxation can reduce the profitability of a business, making it less appealing to investors.

On the flip side, LLCs offer flexibility in taxation. Members of the LLC can choose to have the business taxed as a sole proprietorship (disregarded entity), partnership, S corporation, or even a C corporation. This flexibility allows for the tax structure that best suits their financial situation.

For instance, an LLC taxed as an S corporation can allow members to save on self-employment taxes by splitting income between wages and distributions. This can enhance the business's financial efficiency, making it a more attractive investment.

Pass-through taxation also simplifies the tax filing process. This simplicity can appeal to investors, who prefer avoiding the complexity and cost associated with corporate tax filings.

The ability to deduct business losses on personal tax returns can be beneficial, especially in the early stages of a business. Investors can offset these losses against other income, reducing their tax liability. This potential for tax savings can make investing in an LLC a more appealing option.

Ability to Bring in Investors Easily

One advantage of forming an LLC is that it's easy to bring investors into the fold. Corporations often require complex procedures and legal hurdles to issue shares or take on new shareholders.

The primary way LLCs bring in investors is by offering membership interests. Membership interests are the ownership stakes in an LLC, similar to shares in a corporation. Unlike shares, membership interests don't follow strict regulations or corporate formalities. LLCs can offer interest to investors without extensive paperwork, regulatory approvals, or other time-consuming processes.

The process typically involves updating the LLC's Operating Agreement to reflect the new ownership structure. An Operating Agreement is a legal document that outlines:

• How the LLC will operate
• How decisions are made
• How profits and losses will be distributed among members

This document can be easily amended with the consent of the existing members. This makes adding new investors a straightforward and quick process.

Another advantage is privacy. LLCs don't have to issue new membership interests publicly--not necessarily true for corporations. An LLC can privately negotiate the terms of the investment with potential investors, allowing for greater flexibility in how deals are structured.

Raising Funds Through Membership Units

Another advantage of LLCs is the ability to raise capital by offering membership units.

Membership units represent ownership stakes in the LLC, similar to how shares represent ownership in a corporation. The difference? Membership units offer greater flexibility in distributing ownership and profits among members.

In a corporation, ownership is typically divided into shares. Each shareholder owns a proportionate amount of the company based on their shares.

Example: Let's say XYZ Inc. is divided into 100 shares and has two shareholders. In this business, Shareholder A owns 75 shares, and Shareholder B owns 25. That means Shareholder A owns 75% of the business, and is entitled to 75% of the value of those shares. Shareholder B owns the remaining 25%.

In contrast, LLCs can structure ownership stakes in a way that reflects the contributions and agreements of the members. LLCs can offer different types of membership units with varying rights, responsibilities, and profit-sharing arrangements.

Example: An LLC might issue preferred membership units to certain investors, which gives them higher priority for profit distributions. The LLC might offer regular membership units to other investors, with different terms and conditions.

This customization allows the LLC to tailor investment opportunities, making it easier to attract a diverse range of investors.

Another benefit of raising funds through membership units is that it allows the LLC to maintain control over the business. Unlike issuing shares in a corporation, LLCs can structure membership units in a way that preserves the decision-making power of the founding members.

Example: An LLC can issue non-voting membership units to investors. This allows a share of the profits without giving them a say in business operations. Some investors only want financial returns, not day-to-day involvement in the business.

Attracting Private Investors and Venture Capital

The LLC structure is particularly appealing to venture capitalists (VCs) and private equity investors for several reasons:

• Customized profit distribution
• Control and influence over management
• Easy structuring and exit options
• Tax advantages

We've covered some of these topics, but it's worth diving into why these benefits appeal to private investors and venture capitalists.

Customized Profit Distribution

What does any investor want? Most often, the answer is ROI (return on investment)!

Venture capitalists and private investors are no different. LLCs offer flexible profit-sharing arrangements, allowing these investors to structure deals that align with their objectives. For example, an LLC can allocate profits to provide a higher return to investors who take on more risk or who contribute more capital. VCs and PE investors often have complex financial models and need their investments to yield the highest possible returns.

Control and Influence Over Management

Another significant advantage for VCs and private equity firms is the ability to influence the governance of the LLC. Unlike corporations governed by a board of directors, LLCs offer more flexible management structures.

VCs and PE firms often seek a say in the strategic direction of the companies they invest in. An LLC allows these investors to negotiate specific governance rights, such as the ability to appoint managers or require certain decisions to be approved by the investors. This flexibility ensures that VCs and PE firms can protect their investments by having a direct impact on key business decisions, such as:

• Mergers and acquisitions
• Major expenditures
• Strategic pivots

Ease of Structuring and Exit

Private equity firms and VCs often structure their investments with an eye on the eventual exit—whether through a sale, merger, or public offering.

LLCs provide flexibility in structuring these exits because the operating agreement can specify how members can sell their interests, redeem shares, or distribute assets upon dissolution. This adaptability can make it easier for VCs and PE firms to exit their investments under favorable conditions.

Additionally, LLCs are often seen as easier and quicker to set up and dissolve compared to corporations, reducing the administrative burden. This is particularly important for these investors. They often have multiple investments and need to move quickly to capitalize on market opportunities.

Tax Advantages

The pass-through taxation of LLCs is another major draw for VCs and PE investors. They can potentially realize more significant after-tax returns on their investments.

Moreover, the ability to pass through losses can be advantageous in the early stages of an investment, where the company might be operating at a loss. These losses can be used to offset other income, providing immediate tax benefits to the investors.

Flexibility in Raising Capital

For private equity and venture capital, the flexibility of LLCs in raising additional capital is also attractive. LLCs can bring in new investors or raise additional capital without the scrutiny and complexity that a corporation might face. VCs and PE firms can scale their investments more efficiently and respond quickly to additional capital needs as the business grows.

The LLC structure’s flexibility in profit-sharing, governance, tax benefits, and capital-raising makes it an ideal choice for venture capitalists and private equity firms. These investors value the ability to structure deals that maximize returns, maintain control over management, and benefit from favorable tax treatment—all of which is possible with an LLC structure.

Reduced Regulatory Burden

LLCS have a reduced regulatory burden compared to corporations. This can make fundraising easier for LLCs, particularly for small businesses and startups.

Unlike corporations, LLCs are not required to hold annual meetings or maintain a board of directors. This has a double benefit:

• Reduced administrative burden
• Owners can dedicate more time to growing their business with activities like fundraising

LLCs are generally exempt from many of the securities regulations that apply to corporations when they issue shares to the public. As a result, LLCs can raise funds more quickly and with fewer legal and financial barriers.

Investors often prefer to invest in entities with fewer regulatory constraints, as this can lead to quicker returns and a more flexible investment structure.

Legal Protections for Investors

LLCs offer strong legal protections to business owners. These protections provide investors with the confidence they need to invest.

One of the most significant legal protections an LLC offers is in the name: limited liability.

Because an LLC is a separate legal entity from its members, they (and investors) are generally not personally liable for the debts or obligations of the company. The personal assets of the investors—such as their homes or savings—are protected. They risk only the amount they invested in the LLC. This liability protection makes LLCs a safer investment compared to partnerships or sole proprietorships, where personal liability is unlimited and asset protection is non-existent.

Additionally, LLCs are flexible in business management and profit-sharing.

Investors can negotiate terms within the agreement to protect their rights and interests. For example, they might secure certain voting rights, profit preferences, or exit strategies aligning with their investment goals.

Real-Life Examples of LLC Fundraising Success

The flexibility and advantages of the LLC structure have enabled many businesses to raise capital and achieve growth.

Here are a few real-life examples of LLCs attracting investors and securing funding.

Airbnb: From Startup to Hospitality Giant

Airbnb, founded in 2007, began as an LLC, which played a crucial role in its early fundraising efforts. The founders, Brian Chesky, Joe Gebbia, and Nathan Blecharczyk, initially struggled to gain traction with investors.

However, the flexibility of the LLC structure allowed them to negotiate favorable terms with early backers. The most significant breakthrough came when they secured $600,000 in seed funding from Sequoia Capital and Y Ventures with a famously well-done pitch deck.This investment helped Airbnb expand its platform and gain a foothold in the competitive hospitality industry.

Airbnb's ability to offer customized membership interests to investors without corporate formalities made it easier to attract capital. The company continued to leverage its LLC structure until it restructured into a corporation in 2020. The business was valued at 82 billion USD in September 2024!

Blue Apron: Cooking Up Success

Blue Apron, the meal-kit delivery service, is another example of a company that successfully raised capital as an LLC. The LLC structure allowed Blue Apron to negotiate flexible terms with investors, which was particularly appealing in the early stages when the company was still refining its business model.

The company continued to raise capital, securing $135 million in 2015.The LLC structure helped Blue Apron offer different types of membership units to investors, allowing for tailored investment terms that catered to various investor preferences. This approach helped the company expand rapidly before it transitioned to a corporation and went public in 2017​.

Snapchat: From an LLC to a Social Media Powerhouse

Snapchat, now known as Snap Inc., also started as an LLC when it was founded in 2011. The founders used the LLC structure to raise early-stage funding quickly and efficiently. Snapchat's unique approach to social media, combined with its LLC structure's flexibility, attracted venture capitalists' attention. In its first year, Snapchat received a $485,000 seed round led by Lightspeed Venture Partners.

The LLC structure allowed Snapchat's founders to retain control over the company while offering investors terms aligned with their financial and strategic goals. This early success in fundraising was crucial in enabling Snapchat to develop its platform and grow its user base. Snapchat was restructured as a corporation in 2017.

These examples highlight the effectiveness of the LLC structure in raising capital. Companies like Airbnb, Blue Apron, and Snapchat were able to:

• Leverage the flexibility and advantages of the LLC to attract investors
• Negotiate favorable terms
• Secure the funds needed to grow and succeed

By offering tailored investment opportunities and reducing regulatory burdens, LLCs provide a powerful platform for businesses looking to raise capital and achieve long-term success.

Make Raising Capital Easier With An LLC

The LLC structure offers significant advantages in raising capital: flexibility, reduced regulatory burdens, and strong legal protections.

These features make it easier for entrepreneurs who set up an LLC to attract and secure funding. Plus, you don't need to sacrifice control over operations.

By offering tailored investment opportunities, your LLC can be a no-brainer for investors.

Thinking about fundraising for your LLC (or creating an LLC)? Get legal advice from a legal professional and financial input from a financial advisor. Together, you can develop a strategy that makes the process as easy as possible, maximizes these benefits, and ensures your long-term success.

FAQs

What are the advantages of an LLC for investors?

LLCs offer several key advantages:

• Flexibility: LLCs offer flexibility in management structure, profit distribution, and investor onboarding. This allows them to tailor investment opportunities to the specific needs and preferences of different investors.
• Pass-through taxation: LLCs can choose to be taxed as a pass-through entity. This means profits and losses are passed through to the members' individual tax returns. This can result in significant tax savings for investors.
• Easy investor onboarding: LLCs can bring in new investors by offering membership interests without complex procedures or public disclosures. This makes investing easier and offers privacy.
• Reduced regulatory burden: LLCs have fewer formalities and regulations than corporations, making them more appealing to investors who prefer less red tape.
• Legal protections: LLCs offer limited liability protection to their members, which can give investors more confidence in their investment.

Why are venture capitalists and private equity firms attracted to LLCs?

Venture capitalists (VCs) and private equity firms are attracted to LLCs for several reasons:

• Customized profit distribution: LLCs allow for flexible profit-sharing arrangements. Agreements can be tailored to the needs and preferences of VCs and private equity firms.
• Control and influence over management: LLCs offer more flexible management structures than corporations. This gives VCs and private equity firms more control over the companies they invest in.
• Ease of structuring and exit: LLCs are easier to set up and dissolve than corporations, and they offer more flexibility in structuring exits, such as through a sale or merger.
• Tax advantages: The pass-through taxation of LLCs can result in significant tax savings for VCs and private equity firms.

Are there any disadvantages or limitations to using an LLC for fundraising?

While LLCs offer many advantages for fundraising, there are also a few potential disadvantages or limitations to consider:

• Limited liability can be a double-edged sword: While limited liability protects members from personal liability for the company's debts, it can also make it more difficult for LLCs to obtain loans or other forms of financing.
• Some investors may prefer corporations: Some investors may prefer to invest in corporations because they are more familiar with the corporate structure and its regulations.
• LLCs can be more complex to manage than sole proprietorships or partnerships: LLCs require more formalities and paperwork than sole proprietorships or partnerships, which can add to the administrative burden for business owners.

What steps should I take if I'm considering forming an LLC to raise capital?

First, consult our ultimate guide to forming an LLC. It will walk you through the entire process of creating an LLC (such as choosing your business name, selecting a registered agent, and filing Articles of Organization).

Additionally:

• Do your research: Learn about the advantages and disadvantages of LLCs, and compare them to other business structures.
• Consult with an attorney: An attorney can help you understand the legal requirements for forming and operating an LLC in your state.
• Develop a business plan: A well-written business plan will help you attract investors and secure funding.
• Network with potential investors: Attend industry events, connect with investors online, and pitch your business to potential investors.
• Be prepared to negotiate: Investors will want to negotiate their investment, so expect to talk about equity ownership, profit sharing, and management control.