{"id":4826,"date":"2016-04-04T10:47:45","date_gmt":"2016-04-04T15:47:45","guid":{"rendered":"https:\/\/content.findlaw-admin.com\/ability-law\/smallbusiness\/incorporation-and-legal-structures\/five-investor-issues-to-consider-when-choosing-a-business.html"},"modified":"2025-10-27T23:18:00","modified_gmt":"2025-10-28T04:18:00","slug":"five-investor-issues-to-consider-when-choosing-a-business","status":"publish","type":"page","link":"https:\/\/www.findlaw.com\/smallbusiness\/incorporation-and-legal-structures\/five-investor-issues-to-consider-when-choosing-a-business.html","title":{"rendered":"Investor Issues To Consider When Choosing a Business Structure"},"content":{"rendered":"\n
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Investor Issues To Consider When Choosing a Business Structure<\/h1>\n\n
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\n By Jade Yeban, Esq.<\/a> | Legally reviewed by Catherine Hodder, Esq.<\/a>\n | Last updated\n
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Editorial Note: We earn a commission from affiliate partner links on FindLaw. Commissions do not affect the editorial integrity of our legal content.<\/p>\n\n <\/div>\n \n

\n \n <\/i>\n Legally Reviewed\n <\/summary>\n\n
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This article has been written and reviewed for legal accuracy, clarity, and style by FindLaw\u2019s team of legal writers and attorneys<\/a> and in accordance with our editorial standards<\/a>.<\/em><\/p>\n\n <\/div>\n <\/details>\n\n

\n \n <\/i>\n Fact-Checked\n <\/summary>\n\n
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The last updated date refers to the last time this article was reviewed by FindLaw or one of our contributing authors<\/a>. We make every effort to keep our articles updated. For information regarding a specific legal issue affecting you, please contact an attorney in your area<\/a>.<\/em><\/p>\n\n <\/div>\n <\/details>\n<\/section>\n\n\n

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Key Takeaways<\/h2>\n

Investors should carefully consider how their investment into a business may affect their personal liability<\/span>, taxation, and reporting requirements<\/span>.<\/p>\n\n <\/div>\n <\/div>\n<\/div>\n\n\n

When starting a small business<\/span>, choosing the right business structure<\/span> is crucial. Entrepreneurs<\/span> must consider how income tax<\/span>, personal liability<\/span>, and the need for venture capital<\/span> will affect their plans. Whether it\u2019s a sole proprietorship<\/span>, a limited liability company<\/span>,\u00a0or a C corporation<\/span>, each form has its own tax treatment<\/span> and filing requirements.\u00a0<\/p>\n

Understanding the difference between tax-exempt<\/span> entities and those that face double taxation<\/span> can save business owners<\/span> from future headaches. Bylaws, operating agreements<\/span>, and the class of stock<\/span> are also vital components to consider. The right legal entity<\/span> can protect personal assets<\/span> and influence the ease of obtaining capital.<\/p>\n

An important consideration in deciding what\u00a0organization form<\/a>\u00a0your business will take is the type of investor the business has or is seeking. For example, a sole proprietorship<\/span> that is actively seeking investment may want to reconsider how the business entity<\/span> is formed. See FindLaw\u2019s\u00a0Start-Up<\/span> Financing<\/a>\u00a0section for more information about funding your new business<\/span>.<\/p>\n

Below are some questions to consider when deciding how the makeup of your investors will influence what form of business<\/span> you will create.<\/p>\n

Need help with business formation? Our trusted partner LegalZoom makes it easy\u2014packages start at $0 + state filing fees.<\/a><\/b><\/em><\/p>\n

1. Will the business be heavily dependent on investors for its capital?<\/h2>\n

Some businesses rely on sales to build their capital. Others must rely on investors to raise the amount of money they need to get started or to expand. One type of business<\/span> that might depend on investment is a company that produces software. While it may have an excellent idea, the company cannot pay its staff of developers or market its product until it has something to sell.\u00a0<\/p>\n

If a business will need a large amount of invested money, its organizers should pick an entity that will be attractive to the kind of investors that best fit its needs. This may mean forming a corporation<\/a>. This represents the best opportunity for an\u00a0initial public offering<\/a>\u00a0(IPO<\/span>), a tantalizing prospect for investors.<\/p>\n

If your business relies on investors for capital, you\u2019ll need to understand their expectations. Investors might be looking for equity, which means sharing ownership interest through shares of stock. This is common in corporations<\/a> where stockholders invest in exchange for a piece of the business.\u00a0<\/p>\n

Tax consequences<\/span> and reporting requirements<\/span> also become more complex. Businesses must file income <\/span>tax<\/span> returns<\/span> that align with the Internal Revenue Code<\/span>, and they must adhere to corporate laws. This dictates how annual reports are managed. A general partnership<\/span> or sole proprietorship<\/span> may have fewer complexities, but it also offers less protection against personal liability<\/span>.<\/p>\n

2. What kind of investors is the company seeking?<\/h2>\n

Identifying the type of investors you want is key. When deciding what business form to choose, a business should consider its financing needs. Investors can come from many different areas, such as\u00a0friends and family, individuals involved in the business, the business\u2019s suppliers or partner companies,\u00a0venture capitalists<\/a>, and others. Each type of investor has similar desires but very different needs. For example, none of them want to be liable for the business\u2019s debt should the venture fail.\u00a0<\/p>\n

Partnerships and\u00a0LLCs<\/span><\/a>\u00a0are financed with contributions and loans from partners,\u00a0members,\u00a0and others. Corporations can issue stock<\/span> to shareholders and raise money through bonds and other debt instruments. If you\u2019re looking for\u00a0venture capital<\/span><\/a>, you may lean towards incorporation, which is more attractive to these types of investors. C corporations<\/span><\/a> allow for various classes of stock<\/span>, which can be appealing to those looking to invest without immediate tax returns<\/span>.\u00a0<\/p>\n

For smaller, more personal investments, a sole proprietor or general partnership<\/span> may be more suitable. Remember, getting legal advice early on can help navigate the tax-exempt<\/span> status and personal <\/span>tax<\/span> implications<\/span> that come with different investors.<\/p>\n

3. What business forms are most attractive to investors?<\/h2>\n

Investors like to minimize their risk. That generally means that a business entity<\/span> that provides a liability shield is preferable.\u00a0C corporations<\/span><\/a>\u00a0often catch the eye of investors due to their ability to issue different classes of stock<\/span> and their established structure, including a board of directors<\/span>. These features can make them ideal for raising venture capital<\/span>. However, they come with the downside of double taxation<\/span> \u2014 once at the corporate level<\/span> and again with distributions<\/span> at the personal income level. There is a way for a corporation to elect S corporation<\/span> status to become a pass-through entity. This way the investors can report the profits and losses on their individual <\/span>tax returns<\/span>. This avoids the double taxation<\/span> of corporate tax<\/span>.<\/p>\n

On the other hand, a sole proprietorship<\/span> may not be as attractive since it doesn\u2019t separate personal assets<\/span> from business debts. This puts personal assets<\/span> at risk. Entrepreneurs<\/span> must weigh the pros and cons of each structure, including the federal tax and personal <\/span>tax<\/span> rates<\/span>, to determine which will be most attractive to potential investors.<\/p>\n

In a partnership, an investor would effectively become a partner by contributing capital and sharing in the right to manage and receive profits. In a limited partnership (LP), a general partner<\/span> has no liability shield, while a limited partner<\/span> is a passive investor. Their liability is limited to the amount of their contribution. With a partnership it is important to have a partnership agreement<\/span> which outlines the rights, responsibilities, and liabilities of the partners.<\/p>\n

A limited liability company<\/span> (LLC<\/span>) is an attractive alternative to a partnership. Members in an LLC<\/span> enjoy liability limitation and taxation similar to a partnership.<\/p>\n

Investors may want to consider what liability protection<\/span> there is when they invest in a company.<\/p>\n

4. Is one goal to raise investment capital without giving up control of the company?<\/h2>\n

Maintaining control while raising capital is a common concern. Several business forms allow a company to balance its desire for financing with its desire to retain control within a select group of individuals. In a\u00a0limited partnership<\/a>\u00a0(LP), only general partners<\/span> exercise management control. A corporation can issue several types of stock, both voting and non-voting. The sale of non-voting shares can prevent the dilution of certain shareholders\u2019 controlling interest.<\/p>\n

With a C corp<\/span>, you can issue non-voting shares of stock. This allows you to raise funds without handing over control to stockholders. The operating agreement<\/span> and bylaws you establish can set the groundwork for how much influence investors have. It\u2019s essential to consult with the Internal Revenue Service (IRS<\/span>) guidelines and seek legal advice to ensure your tax treatment<\/span> aligns with your goals for control and ownership interest.<\/p>\n

5. Might the business become publicly traded at some point?<\/h2>\n

The only business form that can be publicly traded is a corporation. It is possible for a business to start in another form and then be converted into a corporation. If becoming publicly traded is a goal, incorporation is often the way to go.\u00a0<\/p>\n

A C corporation<\/span> is set up for this path, with clear legal distinctions between personal assets<\/span> and business operations, a board of directors<\/span> to oversee corporate governance, and the ability to sell shares of stock to the public. However, the leap to public trading comes with stringent reporting requirements<\/span> and increased scrutiny from lenders<\/span> and regulators. Preparing for this includes detailed income <\/span>tax<\/span> returns<\/span>, regular annual reports, and adherence to complex federal tax laws.<\/p>\n

Have More Questions? Talk to a Business Attorney<\/h2>\n

Starting a business requires not only hard work and perseverance but also specialized legal skills at times. In particular, a\u00a0business and commercial law attorney<\/a> can help you determine the best legal structure for your business with respect to investor concerns. Then, use an easy, step-by-step DIY service<\/a>\u00a0to form your business legally.<\/p>\n\n\n

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