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Five Investor Issues to Consider When Choosing a Business Form

Five Investor Issues to Consider When Choosing a Business Form

One important aspect in deciding what form a business should take is the type of investors it has or is seeking. For example, a venture capitalist will want an exit strategy several years down the road, often through the company making an initial public offering (IPO). To go public, the company must be a corporation. Below are some questions to consider when deciding how the makeup of your investors will influence what kind of business will be formed.

1. Will the business be heavily dependent on investors for its capital?

Some businesses rely on sales to build their capital, while others must rely on investors to raise the amount of money they need to get started or to expand. One business 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. If a business will need a large amount of invested money, its organizers should select an entity that will be attractive to the kind of investors that best fit its needs.

2. What kind of investors is the company seeking?

When deciding what business form to choose, a business should consider its financial needs. Investors can come from many different areas-friends and family, individuals involved in the business, partner companies, venture capitalists, and others. Each type of investor has similar desires. For example, none of them wants to be liable for the business's debts if it fails. However, each type of investor has different needs. A partner company, which is financing a venture that will be crucial in its own success, may want some control over the business's management. An individual working for the company may want a share of the profits, but may not wish to be directly involved in the day-to-day management. The business also may want the management help of a successful and more experienced company, or it may want to limit control of its management to a few key individuals. Some business entities may even be limited by law as to who can own their shares; for example, a professional corporation may have shares owned only by individuals licensed to provide its type of professional services.

Partnerships and limited liability companies (LLCs) are financed with contributions and loans from partners or members and others. Corporations can issue stock to shareholders and raise money though bonds and other debt instruments.

3. What business forms are most attractive to investors?

Investors want to minimize their risk. Generally, this means that a business entity that provides a liability shield is preferable. In a partnership, an investor would effectively become a partner by contributing capital and sharing in the right to manage and to receive profits. However, partnerships provide no liability shields. A limited liability partnership (LLP) can receive investment contributions from either general partners or limited partners. A general partner has no liability shield. However, a limited partner's liability is limited to the amount of his or her contribution. Members in a limited liability company (LLC) also enjoy a liability limitation.

Only corporations provide a liability shield all investors and can issue stock. Stock can be issued either as voting shares (which allow shareholders some control of the company) or non-voting shares. A corporation can issue just a few shares to a small number of shareholders, including investors, or it can make a public offering to the broader market of investors.

4. Is a business goal to raise investment capital without giving up control of the company?

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 an LLP, only general partners exercise management control. A corporation can issue several types of stock, including voting and non-voting. The sale of non-voting shares can prevent dilution of certain shareholders' controlling interests.

5. Might the business eventually become publicly traded?

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 to a corporation. A popular initial form for a business, which may wish to become a corporation at a later date, is an LLC. While an unlimited number of members can be added to an LLC, this will eventually dilute controlling interests and become unwieldy. Conversion to a corporation will allow the company to decide what types of shares it wishes to issue, and to whom.

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