Why US VCs don’t use LLCs, and why Latin American startups might want to

This is a post in a series of posts about Latin American startup structures. See the main post.

You’ve probably heard that VCs won’t invest in Limited Liability Companies (LLCs). It’s generally true. And there’s good reasons for it. LLCs are a no go for most VCs because of excess paperwork and potential tax liability for the investors in a VC fund, even though the investors might not get any cash payout.

Most VCs generally don’t like LLCs because both income and expenses flow through to the LLC members. This means that LLCs issue K-1 tax forms to all members that include their pro-rata share of income and expenses on it. Since most VCs are either LPs or LLCs, they have to put the income or expenses from the LLC onto their own K-1s that go to their investors (LPs).

In addition to being a paperwork headache, if your company is profitable and you don’t distribute dividends (which an early stage startup shouldn’t be doing), VCs will need to report taxable income to their LPs when they are not getting cash. This is a no-go for VCs, and many operating agreements for VCs expressly prohibit showing taxable income without getting a cash distribution.

Magma and some LatAm VCs are willing to take this risk at pre-seed and seed, as the chances that there will be profits are very low, but many funds will not invest in LLCs, full stop.

LLCs might be attractive to pre-seed and seed Latin American startups that operate in Latin America. LLCs are cost effective and give you the ability to switch to a Delaware C Corp or another more complicated structure at a later date. If you want to go into greater detail, please check out Legal Structures for Latin American Startups.

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