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70 Hastings L.J. 409 (2018-2019)
Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups

handle is hein.journals/hastlj70 and id is 409 raw text is: 













  Explaining Choice-of-Entity Decisions by Silicon

                              Valley Start-Ups



                                   GREGG POLSKYT


Perhaps the most fundamental role of a business lawyer is to recommend the optimal entity
choicefor nascent business enterprises. Nevertheless, even in 2018, the choice-of-entity analysis
remains highly muddled. Most business lawyers across the United States consistently
recommend flow-through entities, such as limited liability companies and S corporations, to
their clients. In contrast, a discrete group of highly sophisticated business lawyers, those who
advise start-ups in Silicon Valley and other hotbeds of start-up activity, prefer C corporations.


Prior commentary has described and tried to explain this paradox without finding an adequate
explanation. These commentators have noted a host of superficially plausible explanations, all
of which they ultimately conclude are not wholly persuasive. The puzzle therefore remains.


This Article attempts to finally solve the puzzle by examining two factors that have been either
vastly underappreciated or completely ignored in the existing literature. First, while previous
commentators have briefly noted that flow-through structures are more complex and
administratively burdensome, they did not fully appreciate the source, nature, and extent of these
problems. In the unique start-up context, the complications of flow-through structures are
exponentially more problematic, to the point where widespread adoption of flow-through
entities is completely impractical. Second, the literature has not appreciated the effect of
perplexing, yet pervasive, tax asset valuation problems in the public company context. The
conventional wisdom is that tax assets are ignored or severely undervalued in public company
stock valuations. In theory, the most significant benefit of flow-through status for start-ups is
that it can result in the creation of valuable tax assets upon exit. However, the conventional
wisdom makes this moot when the exit is through an initial public offering or sale to a public
company, which are the desired types of exits for start-ups. The result is that the most significant
benefit of using a flow-through is eliminated because of the tax asset pricing problem.
Accordingly, while the costs of flow-through structures are far higher than have been
appreciated, the benefits of these structures are much smaller than they appear.


      Francis Shackelford Distinguished Professor in Taxation Law, University of Georgia School of Law.
Thanks to Brad Bernthal, Brian Broughman, Jason Breen, Omri Marian, Usha Rodrigues, Gladriel Shobe, and
Larry Zelenak for comments on earlier drafts and to Robert Daily for research assistance.

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