Many startup founders decide to start their venture by becoming an LLC. There are very good reasons for this: LLCs are tax flow-through structures: they allow you to write off any LLC losses from your other income. In addition, the tax implications of selling an LLC is relative favorable when compared to the sale of other business structures.
When a startup is in its infancy, and it is unclear whether and how its success will grow, an LLC is a relatively low-hassle, low-cost option with which founders can hit the ground running. As the startup develops, however, there are many compelling reasons to consider converting from an LLC to C Corp.
C Corp vs LLC
The tax and regulatory advantages of LLCs might influence your decision to start out by becoming an LLC, but as soon as you start looking toward competitive hiring and possible investment, you will want to convert your LLC to a C Corp. There are several reasons for this, most of them arising from the fact that a C Corp has authorized shares of stock.
Venture Capitalists strongly (and often exclusively) prefer investing in Delaware C Corps. It allows for the creation of preferential shares that the investors can take ownership of. And, because of the current industry-wide practice of investing in Delaware C Corps, it allows investors to record a consistent legal structure across portfolios. Finally, some VCs use public funds, which is often prohibited from being applied to investment in LLCs.
Startup accelerators and incubators also strongly prefer taking equity from participants that are incorporated as C Corps–it allows for seamless calculation and distribution of equity
C Corps, and more specifically, Delaware C Corps, are standard practice across the startup industry. This is not only important for future investors, but also for future employees. If you want to attract reputable talent, you’d be best placed to do so if you can offer shares of stock in a C Corp.
If you are entering your startup’s growth phase and you are planning on hiring, a C Corp allows for significant tax benefits. LLCs have to pay taxes on employee benefits that C Corps are not liable for.
How to convert your LLC to C Corp?
There are three main ways through which you can convert an LLC to C Corp.
1. Statutory Conversion
A statutory conversion is the easiest way to convert your startup from LLC to C Corp. It is also referred to as the “fast-track” process, and is not available in all states. Delaware and California are two states that do allow for statutory conversion, for example. The process is more or less similar in all states that allow for this conversion.
You will need to obtain approval from the majority of LLC members for the conversion. The exact manner and percentage of approval that you need will depend on the provisions in your LLC operating agreement.
When approval has been finalized, file a certificate of conversion and a certificate of incorporation (for the incorporation of the new C Corp) at the secretary of state and pay the conversion fee.
Note that this fast-track procedure is usually only available if you are planning to convert your LLC to C Corp in the same state. In other words, if you have an LLC in one state, and you want to convert it to a C Corp in another state, you might have to use options 2 or 3 below.
For the statutory merger process, you will essentially create a C Corporation and then merge your LLC and that Corporation. The process will more or less look as follows:
Incorporate a C Corp.
Have a your LLC members vote for approval to become stockholders and not members
The LLC members can then legally change their membership rights to agreed-upon shares in the C Corp.
Merge the LLC and the C Corp. This will almost always require that you file a certificate of merger with your secretary of state, and there might be other requirements as well, depending on your state and the specifics of the merger.
You can also, of course, liquidate your LLC and separately incorporate a new C Corporation. Although this option is always available, it is not ideal for purposes of your company’s corporate history and it is also unnecessarily complicated.
Additional steps to keep in mind
Regardless of the method of conversion that you opt for, there are a few additional general steps that you will have to take:
Calculating and getting approval for the pre and post conversion capitalization of the startup
All necessary post-incorporation documents for the new C Corp.
Filing a short tax year return as soon as your LLC stops existing. All members who do not do this, are liable for a monthly fine.
Feel free to visit LawTrades for help with your startups conversion from LLC to Corp. The attorneys on our marketplace help startups and established companies with business structuring and restructuring regarding both the legalities of formation and tax implications.