Are Venture Capital Investments Inefficiently Organized? Quantifying the foregone tax losses generated by startup firms organized as C corporations

Abstract

Current practice dictates that loss-generating startup firms organize as C corporations rather than the theoretically more tax efficient alternative—the limited liability company. We measure the cost of this divergence between theory and practice and find that 83.32% of our sample of 1,067 startup firms that conduct an IPO report accumulated tax losses of $31.96 billion at issuance. The losses are estimated to represent foregone tax benefits with a present value from $1.4 billion to $4.4 billion, depending on the type of investor assumed to utilize them. This is the first quantification of the tax benefits foregone by the current organizational structure and represents a lower bound estimate of the non-tax costs market participants assign to switching to the limited liability company (LLC). We also investigate the distinguishing characteristics of the 19 firms in our sample that receive venture capital funding and remain LLCs until IPO. These firms are generally more profitable and less reliant on venture capital than those that organize as C corporations.