One of the earliest and most fundamental legal decisions an entrepreneur must make is whether to organize as a sole proprietorship, a general partnership, a limited partnership, a corporation, or a limited liability company (LLC). There are countless resources on the Internet about the tax, limited liability, and complexity issues underlying the decision of choice of entity. What is missing, however, is up-to-date information from an authoritative source about what entity most organizers choose in the year 2012.
To answer this question (and many more to come), I drew upon a resource that has been almost untapped by scholars—Form D filings. Form D is a filing that is required to be made with the Securities and Exchange Commission when companies raise money in reliance on Regulation D, which is one of the most commonly used exemptions from the registration requirements of the Securities Act of 1933.
The individual Form D is a very simple filing with only a handful of items of information, but collectively they are a treasure trove of information about private companies that would otherwise be very difficult to find. They reveal the type of organizational entity (corporation, LLC, etc.), the state of organization of the entity, the officers and directors, the amount of money raised, proceeds used to pay insiders, the number and type of investors, as well as revenue data for some companies (more to come about this later). The Form D allows us to peer into how entrepreneurs are organizing private companies, and the companies filing Form Ds are exactly the “right kind” of private companies for understanding entrepreneurial choices—those that have actually raised external funds, rather than inactive or “shelf” companies, “incorporated proprietorships” or wholly owned subsidiaries of other businesses.
To find out how companies that raise funds are being organized, I downloaded all Form Ds filed between July 1, 2009 and May 29, 2012. This gave me a dataset of 91,908 total filings by 48,881 companies. I excluded various types of companies and filings that were likely to be misleading, such as filings by “pooled investment funds” that have peculiar organizational forms uncommon to most businesses. That left me with 26,555 companies. Taking one Form D per company, I calculated what percentage of companies formed in each year from 2004 to 2012 were organized as corporations, limited liability companies, and limited partnerships.
What are the results? The proportion of each type of entity reflected in the Form D filings is set forth in Figure 1, below.
The majority of companies in recent years are organizing as LLCs, not as corporations, and that is a dramatic change over the last 8 years. As recently as 2004 (the earliest point in the dataset), companies filing Form D were overwhelmingly organized as corporations (83% of total formations). But the results clearly show that the corporation has undergone a tremendous decline since that time. After 2008, the corporation accounted for less than half of the entity formations, and by 2012, the corporation accounted for only 27% of the total formations. Indeed, if current trends continue in the span of less than a decade, the LLC and the corporation will trade places, with the LLC as the dominant organizational form.
The growth of market share by LLCs is a trend that scholars have seen coming for quite some time, but this is the first data from an authoritative source showing the clear dominance of the LLC as an organizational form among companies seeking external financing. This is important because for many years, it was thought that corporations were the preferred vehicle for entrepreneurs seeking outside financing. Although corporations are still the most common organizational form for companies going public or seeking venture capital investments, there is no necessary reason for either of those patterns, so we may see changes there in coming years as well.
Why has the limited liability company taken over? See here for an introduction to a book by one of the foremost authorities on these “uncorporations.” In the next post, I will look at which states are attracting incorporations and formations from entrepreneurs.