It has long been the case that venture funds (classified as partnerships for tax purposes) have insisted that limited liability companies (LLCs) taxed as partnerships convert to C corporations prior to the consummation of a venture financing. Most commonly, there are three rationales given for this requirement: (1) certain venture fund limited partners are tax exempt institutions or foreign investors and prohibit the venture fund from allocating Unrelated Business Taxable Income or Effectively Connected Income to such types of limited partners that likely would result from an investment directly into an LLC, (2) venture funds are focused on the potential of a future initial public offering (IPO) and the most common vehicle to an IPO is a C corporation and (3) executive talent expects to be issued stock options and are not familiar with the more complex equity issued by an LLC.
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