SaaS3 min read
LLC vs C-corp for SaaS: the answer depends on whether you raise
This is the one entity question in software where both answers are right for different companies. The deciding fact is not your revenue or your state. It is whether a fund will own part of this business.
Published
Almost every other business model in this catalogue has one correct entity and a set of edge cases. SaaS has two, and choosing wrongly is expensive in both directions.
The single question
Will an institutional fund own equity in this company?
Everything else follows from the answer, and you generally know it about yourself before you know anything else about the business.
The comparison in full
| LLC | Delaware C-corp | |
|---|---|---|
| Tax on profit | Once, in the owners' hands | At the company, then again on distributions |
| Early losses | Flow through to owners' returns, subject to basis, at-risk and passive-activity limits | Trapped at the company as carryforwards |
| Investor acceptance | Most funds cannot or will not hold LLC interests, partly for their own tax reasons | The structure the entire venture stack assumes |
| Employee equity | Profits interests — workable, unfamiliar, hard to explain to a candidate | Option pool and ISOs, understood by everyone |
| Gain on exit | Ordinary rules | Section 1202 QSBS can exclude a substantial share of gain if the tests are met |
| Governance | An operating agreement you can shape freely | Board, bylaws, minutes, and a corporate calendar |
| Annual cost | Low | Franchise tax, a corporate return, and usually a lawyer |
The case for the LLC
- One layer of tax. For a profitable bootstrapped business distributing cash to its owners, this is decisive.
- Early losses are usable now, against other income, subject to the limitations. A C-corp's losses sit unused until it is profitable.
- The Section 199A deduction — up to 20% of qualifying pass-through profit, made permanent by P.L. 119-21 — applies to the LLC's profit and not to a C-corp's.
- Far less administration. No board, no minutes, no separate corporate return.
The case for the C-corp
- Funds are set up for it. Preferred stock, protective provisions, drag-along rights and safes all assume a Delaware corporation.
- Options are a solved problem. Hiring against equity is materially easier when candidates recognise the instrument.
- QSBS. Section 1202 can exclude a large portion of gain on qualifying stock. It requires a C-corp, and the holding period means it rewards being one early.
- Delaware law is predictable, with a body of case law and a court that hears these disputes constantly.
Converting, and the timing that always goes wrong
An LLC can convert to a Delaware corporation, and thousands do every year. It costs legal fees and a few weeks, and it has tax consequences that depend on the specifics.
The recurring pattern is that it becomes urgent in the same fortnight as a term sheet, when your attention is needed elsewhere and your leverage is lowest. If a raise is plausible within a year, the cheap moment to be a corporation is now.
The honest middle case
Many founders genuinely do not know. A reasonable default: if you are building something you would be happy to run at $2m of revenue with two people, be an LLC. If you are building something that only makes sense at $50m and needs capital to get there, be a corporation. The uncomfortable answer is that pretending to be undecided usually means the first one.
Whichever you pick, it needs maintaining
Founders 8 holds the entity, the filings and the deadlines — including the corporate calendar a C-corp adds.
Build your workspaceThis is one section of the saas structure guide, which covers the entity choice itself.
Founders 8 does not provide tax advice. Tax residency depends on facts and rules specific to each jurisdiction — review your position with a qualified adviser.