Most startups convert from an LLC to a C-Corp when they first formally fundraise.
True. But the 5 year holding period
doesn't start until conversion to a c-corp. So, plan accordingly.
This is true, but starting as an LLC and converting to a C corp does have a potential QSBS benefit, if you are able to meet the 5-year holding period. The QSBS deduction is the greater of $10 million or 10 times your adjusted basis at the time of acquisition of the C corp stock. If you incorporate as a C corp initially, you get the $10 million deduction, at best. If you form as an LLC and only convert to a C corp (and get your C corp stock) at the time of your first financing, your adjusted basis may be significant. If the value of your equity share is, say, $3 million at the time of your first equity round (not unheard of), when you convert to a C corp, you potentially get a QSBS deduction of 10 times that (i.e. $30 million).
Please note that in a conversion from LLC to C corp, you only get the QSBS on the gain over the initial basis. So, in my example above, if you end up selling the shares for $2 million in an exit (when the basis when you received the shares was $3 million), you will get no QSBS deduction.
but how do you avoid double taxation with a c-corp?
I setup a c-corp via stripe but switched to s-corp because of this.
Most startups on the venture track aren't profitable or reinvest any profits into growing the business. No profits = no tax. So double taxation usually isn't a problem.
But when I hear about a SaaS startup being organized as an LLC, I wonder if the founders considered the potential benefits of "qualified small business stock" or QSBS, which is only available in a c-corp.
With QSBS, each founder and investor can supersize their exit proceeds by wiping out at least $10 million in U.S. taxes. (See https://www.businessinsider.com/qsbs-qualified-small-busines...).