We've been building our product here in Kentucky. It is a cloud based service. We incorporated as a S chapter corporation. Now we are ready to take on investors. Should we dissolve the company here in Kentucky and setup a chapter C corporation in Delaware?

I deal extensively with corporate and securities law for startups, who face the question of what entity type and tax elections to make quite often. The answer to your question is that you may HAVE to make the switch, as S-Corp status may no longer be an option if you are taking on investors. It depends on how many investors you will have and what type of investors they will be. There are a number of requirements in order to be able to elect and maintain S-Corp status. Among them are that you must have less than 100 investors, and those investors must be individuals (or certain types of trusts). If you take on investors that bust either of those requirements (or any of the others not mentioned here), then you would no longer be allowed to elect S-Corp status. If we assume you have the option to keep S-Corp status after you take on investors, we have to look at both investor interests and your business interests. For investors, the question becomes whether they want to be taxed as an S-Corp. There are plenty of reasons that they would not (and would prefer C-Corp taxation), but everyone is different. They might be fine with it. From a business perspective, in order to maintain S-Corp status, you can only have ONE class of stock. This means that your investors would get the same shares as you have, with the same voting rights, etc. However, it is common business practice, especially in a major financing round, for investors to get a new series of preferred shares (e.g. Series A) with rights different than the common shares. In order to do this, you would have to create a new class of shares, which would also require you to switch to C-Corp status (as you would no longer be eligible for S-Corp status). All that said, this is just informational, and I am happy to talk further about your specific situation.

Answered 5 years ago

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