IDEAS home Printed from https://ideas.repec.org/a/spr/reaccs/v28y2023i4d10.1007_s11142-022-09677-1.html
   My bibliography  Save this article

On the tax efficiency of startup firms

Author

Listed:
  • Eric J. Allen

    (University of California, Riverside)

  • Jeffrey C. Allen

    (University of California, Riverside and University of Redlands)

  • Sharat Raghavan

    (University of California, Berkeley)

  • David H. Solomon

    (Boston College)

Abstract

We examine the choice of organizational structure for VC-backed startup firms. These firms overwhelmingly organize as C-corporations rather than as tax advantaged limited liability companies (LLCs). This results in foregone tax savings of $43.9 billion, or 4.9% of the total equity invested in the sample firms. The decision is puzzling, given plausible estimates of the direct costs involved, but appears related to “hassle” and other transition costs generated by participants implementing a new form. Firms with more employees and investors are likely to choose the C-corporation. VCs appear to prefer the C-corporation form, as receiving VC money is associated with most LLC firms switching to a C-corporation within 30 days. Greater VC preferences for C-corporations are linked to a preference for familiarity, and less attention to taxes.

Suggested Citation

  • Eric J. Allen & Jeffrey C. Allen & Sharat Raghavan & David H. Solomon, 2023. "On the tax efficiency of startup firms," Review of Accounting Studies, Springer, vol. 28(4), pages 1887-1928, December.
    • Handle: RePEc:spr:reaccs:v:28:y:2023:i:4:d:10.1007_s11142-022-09677-1
    DOI: 10.1007/s11142-022-09677-1
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s11142-022-09677-1
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.
    File URL: https://libkey.io/10.1007/s11142-022-09677-1?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Sensoy, Berk A. & Wang, Yingdi & Weisbach, Michael S., 2014. "Limited partner performance and the maturing of the private equity industry," Journal of Financial Economics, Elsevier, vol. 112(3), pages 320-343.
    2. Gordon, Roger H. & MacKie-Mason, Jeffrey K., 1994. "Tax distortions to the choice of organizational form," Journal of Public Economics, Elsevier, vol. 55(2), pages 279-306, October.
    3. Thomas Hellmann & Manju Puri, 2002. "Venture Capital and the Professionalization of Start‐Up Firms: Empirical Evidence," Journal of Finance, American Finance Association, vol. 57(1), pages 169-197, February.
    4. Mackie-Mason, Jeffrey K & Gordon, Roger H, 1997. "How Much Do Taxes Discourage Incorporation?," Journal of Finance, American Finance Association, vol. 52(2), pages 477-505, June.
    5. Robert E. Hall & Susan E. Woodward, 2007. "The Incentives to Start New Companies: Evidence from Venture Capital," NBER Working Papers 13056, National Bureau of Economic Research, Inc.
    6. Clemens Sialm & Hanjiang Zhang, 2020. "Tax‐Efficient Asset Management: Evidence from Equity Mutual Funds," Journal of Finance, American Finance Association, vol. 75(2), pages 735-777, April.
    7. Manju Puri & Rebecca Zarutskie, 2012. "On the Life Cycle Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms," Journal of Finance, American Finance Association, vol. 67(6), pages 2247-2293, December.
    8. Elton, Edwin J & Gruber, Martin J, 1970. "Marginal Stockholder Tax Rates and the Clientele Effect," The Review of Economics and Statistics, MIT Press, vol. 52(1), pages 68-74, February.
    9. Robert E. Hall & Susan E. Woodward, 2010. "The Burden of the Nondiversifiable Risk of Entrepreneurship," American Economic Review, American Economic Association, vol. 100(3), pages 1163-1194, June.
    10. Rin, Marco Da & Hellmann, Thomas & Puri, Manju, 2013. "A Survey of Venture Capital Research," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 573-648, Elsevier.
    11. Youssef Benzarti, 2020. "How Taxing Is Tax Filing? Using Revealed Preferences to Estimate Compliance Costs," American Economic Journal: Economic Policy, American Economic Association, vol. 12(4), pages 38-57, November.
    12. Goolsbee, Austan, 2004. "The impact of the corporate income tax: evidence from state organizational form data," Journal of Public Economics, Elsevier, vol. 88(11), pages 2283-2299, September.
    13. Goolsbee, Austan, 1998. "Taxes, organizational form, and the deadweight loss of the corporate income tax," Journal of Public Economics, Elsevier, vol. 69(1), pages 143-152, July.
    14. David Solomon & Eugene Soltes, 2015. "What Are We Meeting For? The Consequences of Private Meetings with Investors," Journal of Law and Economics, University of Chicago Press, vol. 58(2), pages 325-355.
    15. Laura Casares Field & Gordon Hanka, 2001. "The Expiration of IPO Share Lockups," Journal of Finance, American Finance Association, vol. 56(2), pages 471-500, April.
    16. Huberman, Gur, 2001. "Familiarity Breeds Investment," The Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 659-680.
    17. Luna, LeAnn & Murray, Matthew N., 2010. "The Effects of State Tax Structure on Business Organizational Form," National Tax Journal, National Tax Association;National Tax Journal, vol. 63(4), pages 995-1021, December.
    18. Joshua D. Coval & Tobias J. Moskowitz, 1999. "Home Bias at Home: Local Equity Preference in Domestic Portfolios," Journal of Finance, American Finance Association, vol. 54(6), pages 2045-2073, December.
    19. John R. Graham & Alok Kumar, 2006. "Do Dividend Clienteles Exist? Evidence on Dividend Preferences of Retail Investors," Journal of Finance, American Finance Association, vol. 61(3), pages 1305-1336, June.
    20. Paul Gompers & Josh Lerner, 2001. "The Venture Capital Revolution," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 145-168, Spring.
    21. Brad M. Barber & Yi-Tsung Lee & Yu-Jane Liu & Terrance Odean, 2009. "Just How Much Do Individual Investors Lose by Trading?," The Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 609-632, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Tazhitdinova, Alisa, 2020. "Are changes of organizational form costly? Income shifting and business entry responses to taxes," Journal of Public Economics, Elsevier, vol. 186(C).
    2. Bergner, Sören Martin & Bräutigam, Rainer & Evers, Maria Theresia & Spengel, Christoph, 2017. "The use of SME tax incentives in the European Union," ZEW Discussion Papers 17-006, ZEW - Leibniz Centre for European Economic Research.
    3. Peter Egger & Christian Keuschnigg & Hannes Winner, 2008. "Incorporation and Taxation: Theory and Firm-level Evidence," University of St. Gallen Department of Economics working paper series 2008 2008-20, Department of Economics, University of St. Gallen.
    4. Hanlon, Michelle & Heitzman, Shane, 2010. "A review of tax research," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 127-178, December.
    5. Ege Can, 2022. "Income taxation, entrepreneurship, and incorporation status of self-employment," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 29(5), pages 1260-1293, October.
    6. Kazuki Onji & John P. Tang, 2015. "A nation without a corporate income tax: Evidence from nineteenth century Japan," Discussion Papers in Economics and Business 15-12, Osaka University, Graduate School of Economics.
    7. Josh Lerner & Ramana Nanda, 2020. "Venture Capital's Role in Financing Innovation: What We Know and How Much We Still Need to Learn," Journal of Economic Perspectives, American Economic Association, vol. 34(3), pages 237-261, Summer.
    8. Lejour, Arjan & Massenz, Gabriella, 2020. "Income Shifting and Organizational Form Choice : Evidence from Europe," Other publications TiSEM 3138edef-d645-4113-9981-3, Tilburg University, School of Economics and Management.
    9. Bo Becker & Zoran Ivković & Scott Weisbenner, 2011. "Local Dividend Clienteles," Journal of Finance, American Finance Association, vol. 66(2), pages 655-683, April.
    10. Daphne Chen & Shi Qi & Don Schlagenhauf, 2018. "Corporate Income Tax, Legal Form of Organization, and Employment," American Economic Journal: Macroeconomics, American Economic Association, vol. 10(4), pages 270-304, October.
    11. Li Liu, 2014. "Income Taxation and Business Incorporation: Evidence From the Early Twentieth Century," National Tax Journal, National Tax Association;National Tax Journal, vol. 67(2), pages 387-418, June.
    12. Marco Da Rin & María Fabiana Penas, 2017. "Venture capital and innovation strategies," Industrial and Corporate Change, Oxford University Press and the Associazione ICC, vol. 26(5), pages 781-800.
    13. Xavier Giroud & Joshua Rauh, 2015. "State Taxation and the Reallocation of Business Activity: Evidence from Establishment-Level Data," NBER Working Papers 21534, National Bureau of Economic Research, Inc.
    14. Wojciech Kopczuk & Eric Zwick, 2020. "Business Incomes at the Top," Journal of Economic Perspectives, American Economic Association, vol. 34(4), pages 27-51, Fall.
    15. Bilicka, Katarzyna & Raei, Sepideh, 2023. "Output distortions and the choice of legal form of organization," Economic Modelling, Elsevier, vol. 119(C).
    16. Waseem, Mazhar, 2018. "Taxes, informality and income shifting: Evidence from a recent Pakistani tax reform," Journal of Public Economics, Elsevier, vol. 157(C), pages 41-77.
    17. Dmitri Romanov, 2004. "The Corporation As A Tax Shelter: Evidence From Recent Israeli Tax Changes," Bank of Israel Working Papers 2004.17, Bank of Israel.
    18. Edmark, Karin & Gordon, Roger, 2012. "Taxes and the Choice of Organizational Form by Entrepreneurs in Sweden," Working Paper Series 907, Research Institute of Industrial Economics.
    19. William H. Janeway & Ramana Nanda & Matthew Rhodes-Kropf, 2021. "Venture Capital Booms and Start-Up Financing," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 111-127, November.
    20. Ewens, Michael & Gorbenko, Alexander & Korteweg, Arthur, 2022. "Venture capital contracts," Journal of Financial Economics, Elsevier, vol. 143(1), pages 131-158.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:reaccs:v:28:y:2023:i:4:d:10.1007_s11142-022-09677-1. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.