Gust spends no time talking about what happens when you try and sell a C Corp. If it's a stock sale great... if it's an asset sale, incredibly not great... you will have double taxation. This matters. $10M paid to the company for an asset, turns into $6.5M after 35% corp taxes (using general numbers) and then $6.5M than distributed to shareholders, assume 30%+ (20% + state taxes + AMT (for now)) so $6.5M is now $4.55…
For many (if not most) other types of businesses, particularly companies that are going to remain as small- to mid-size, cash generating, businesses that will not require a lot of capital investment, incorporating as an LLC in their home state makes a lot of sense. But for the high-growth startup seeking investor funding, incorporating as a Delaware C corporation is without any question whatsoever the most appropriate, least expensive and most standard way to incorporate.
There certainly are tax differences in the treatment of an asset sale compared to a stock sale. But for the kinds of startups that should be using Gust Launch, that is invariably not an issue, because for those businesses an asset sale generally means a bad exit. In fact, in my entire investing and entrepreneurial career, spanning literally hundreds of companies over two decades, I have never once seen a positive M&A scenario in which the acquirer demanded an asset sale. Instead, most target companies forced into asset sales are being sold for less than their basis and less than the liquidation preference or convertible note balance, so the question of tax on asset gains or liquidation distribution simply does not apply.
@GoRudy is correct that in the subset of acquisitions where there is a gain for the target company, it is highly disadvantageous for the target company's shareholders to structure the transaction as an asset purchase. Realistically, they would be getting a lousy deal, but that would have been caused either by the company not being worth much, not negotiating well, or because it has incurred some troublesome contingent liabilities.
The few times I've seen asset purchases with unfavorable tax treatment, the CEO had signed the highest dollar term sheet offer (or the only available one), and they were either oblivious to the tax implications or else the acquirer did not even mention the form of transaction until starting to negotiate the definitive documents. Companies in that position should absolutely negotiate hard for a stock acquisition, a higher price, or carefully work out some other more advantageous tax structure.
But ultimately there's a more general point to be made here. Startups—and the investors who fund them—optimize for growth and financial upside, not to limit downside or engage in complex tax planning that would limit opportunities.
If you create an LLC structure that generates 20% higher after-tax proceeds in the case of an early exit, but substantially lower proceeds in a successful exit because of (1) the Qualified Small Business tax deduction being unavailable, (2) the requirement to make tax distributions and pay income tax along the way, and (3) making the company generally unfundable, you're setting your company up for failure, not success. Put another way, if you knew at the start that your company were heading for an asset sale, you probably shouldn't be doing it in the first place, and for sure no one else should be investing in it.
We—and the majority of people who work with successful startups—have a similar attitude towards starting a business as an LLC and then reincorporating as a C corporation—at a cost of many thousands of dollars—only if and when the company shows promise. That's like refusing to quit your day job until you know your company will succeed. It's understandable, and might even make sense in some cases, but it limits your odds of success and is telegraphing that you are accepting defeat before even getting started.
[BTW, for those founders concerned about double taxation during the early days of a startup, there’s a way to have your cake and eat it too: incorporate as a Delaware corporation and file a “Sub-chapter S” election with the IRS. That will give you all the benefits of the corporate structure (other than QSB eligibility) but also provide the one level of taxation/pass-through treatment that you would get with an LLC. Note that the requirements for sub-S election are: one class of stock (ie, no investors with Convertible Preferred), only individuals as stockholders (no LLCs, corporates or investment SPVs), and only US-based stockholders.]