How to convert your startup from an LLC to a C Corp? Startup founders often choose an LLC structure because of the ease of setup, administration, and favorable tax implications. However, a C Corp business structure offers a number of features that makes it an option quickly as you grow your business.
When a startup has already validated its product, secured its first few clients, and is getting ready to attend an accelerator or begin a fundraising round, they quickly learn that it could be more favorable to structure the company as a C Corporation.
In spite of the fact that the conversion process isn’t always fun, it can be necessary to take your business to the next level.
Let’s take a look at some of the factors involved, including when to convert, why to convert, and the requirements to convert from an LLC to a C Corp.
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When & Why to Convert Your Startup from a Limited Liability Company
As an entrepreneur, you might think about how to convert your startup from an LLC to a C Corp for some of the following reasons.
You’re looking for investors to help you fund your business:
Generally, investors like to invest their money in C corporations. Why? Because these businesses have more structure and scalability. Investors have the opportunity to transfer their defined shares quickly, so it is easier to buy and sell stock in corporations. Corporations can also offer “preferred stock,” which attracts many investors.
You want to take your business public:
You must first incorporate as a C corporation if you intend to execute your common stock in a public offering.
You wish to compensate your employees with stock:
It’s considerably easier to offer original investors stock as compensation or periodically allocate it to the workforce as part of their standard salary as a C corporation rather than an LLC.
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You are applying to a startup accelerator program:
Startup incubators and accelerator programs frequently require businesses to be incorporated as a C Corp since they take equity or use convertible notes that can be turned into equity.
You would like to restructure your taxes:
LLCs, S Corps, and C Corps all have different tax rules. Including how much you pay as a company, versus personally, and what is paid out as a salary, benefits, or in distributions to owners, as self-employed income.
Converting an LLC startup into an S Corp is like changing its structure or model entirely. For more information about what is a business model, check out this video I have created. You are sure to find it helpful.
How to Convert Your Startup from an LLC to a C Corp?
Now that you are aware of the when and why you need to convert, let’s dive in and take a look at how to transform your LLC into a C Corporation.
There are three common ways to transition your company. Note: The conversion procedures offered may differ by jurisdiction. The paperwork and method for each option vary depending on your startup’s state. This may also be a consideration when originally formalizing your venture, and strategizing fundraising. The last thing you want is to keep on going back in circles or to start from scratch to work out these kinks in your paperwork, instead of getting on with growing the business.
Following are the three basic conversion methods you will have to choose from:
- Statutory Conversion
- Statutory Merger
- Non Statutory Merger
Although the methods differ, the typical steps are the same.
- Make a conversion strategy
- Obtain unanimous consent from all LLC members, or, meet the Articles of Organization‘s minimal voting requirements
- Submit the proper paperwork to the Secretary of State’s office
1. Through a Statutory Conversion
Converting your LLC to a C Corp using the statutory conversion method is a relatively recent, efficient process. It changes LLC associates to stockholders and transfers the assets and liabilities of your LLC to your C Corp.
It is the most straightforward and cost-effective alternative. The general stages for statutory conversion are outlined below.
- Create a conversion strategy
- Get the LLC members’ approval
- File a conversion certificate with other relevant documentation with the secretary of state
One of the reasons this process is more straightforward than others is that the conversion does not require formal assignment agreements.
So, you can use the statutory conversion method to easily change your startup from an LLC to a C Corporation. While the process varies significantly depending on which jurisdictions support statutory conversion, it usually entails creating and approving a strategy to make this conversion and completing the necessary documents with the appropriate regulatory agency of the state you are located in.
A fundamental feature of this type of adaptation is that it involves the automatic shift of the assets and liabilities of the entity from your Limited Liability Company to the newly established C Corporation. In addition, it easily converts the position of all the members of your LLC to the new Corporation’s shareholders. You can avoid the extra steps and documentation necessary in the next two ways.
2. Through a Statutory Merger
If you convert your startup from an LLC to a C Corp through a statutory merger, you will have to form a C Corp, and then subsequently, it can absorb your LLC. The LLC members’ shares in the latest C corporation will be converted into stock. A statutory conversion is a more official procedure.
It is the next best choice if your state does not permit statutory conversion. To follow this business structure type, you must:
- Create a new C Corp that includes all the members from your LLC as stockholders.
- Ask members of the LLC to vote on whether or not to combine. As the members of LLC and corporate stockholders, it is mandatory that they do this.
- Ensure that LLC members formally swap their membership privileges for company shares.
- Submit a merger certificate and any other legally required paperwork with the secretary of state.
Thus, a statutory merger requires the formation of a new entity first. Then, all your Limited Liability Company associates will need to endorse this merger and hand over their Limited Liability Company’s association rights. Afterward, the newly established Corporation must then submit merger documentation and the other documents to a suitable regulatory agency of their state. Lastly, the LLC must be dissolved.
While this procedure, like a statutory conversion, routinely reassigns assets and liabilities, it is a substantially more complex and lengthy procedure due to the additional formalities involved in forming a fresh C Corporation. A statutory merger is a good option in states where statutory conversions are unavailable.
3. Through a Non Statutory Conversion
Nonstatutory conversion involves forming a C Corp and formally assigning all LLC members’ assets, interests, and liabilities to the C Corp through varying legal assignments.
Among all three methods, this method is the most time-consuming and messy. It’s usually only a last resort if your state doesn’t allow the other two methods, i.e., statutory merger or conversion.
The typical steps in this method are as follows:
- Create a new C Corporation
- Transfer the assets and liabilities of the members’ LLC to the corporation in writing.
- Set up a formal exchange of membership interests of all the members of LLC for corporate stock.
- Formally dissolve and liquidate the LLC.
You’re in for a ride if converting through a nonstatutory method is your only option. As it’s only used in rare situations and necessitates a high level of legal assistance, this is the most complicated and, in most cases, highly pricey alternative. It might be a better idea to establish a new corporation, similar to a statutory merger.
Then, using different contracts flanked by your Limited Liability Company and the new C Corporation, you will have to officially transfer ownership interests, assets, and liabilities. As with the other two methods, these transfers do not happen automatically. To finish, you’ll have to close your LLC similarly to a statutory merger. So, take the time to understand in detail how to convert your startup from an LLC to a C Corp.
Finish the Creation of the New C Corporation
The conversion procedure is the most challenging part of the process. However, you’re not done yet. You must still complete the actual formation and organization of your C Corp. Along with the benefits of a C Corporation, there will also be new duties that were not presented when you owned a Limited Liability Company. Your incorporated entity should then elect directors from its pool of shareholders, who will then choose the officers of the Company. The board of directors should assemble and take minutes at every meeting as per the statute. Also, the new corporation will have to issue stock, and possibly meet additional requirements related to financial reporting.
To properly construct a C Corp, you’ll need to complete the remaining regular duties.
These are, in a nutshell:
- Register your business with the Secretary of State.
- Obtain a new EIN
- Draft and pass bylaws
- Elect officers and directors
- Hold or waive inaugural board and stockholder meetings
Note: The Corporation’s tax status is among the variables in the conversion process.
A corporation can be classified as either an S Corp (pass-through taxation) or C Corp (double taxation). Startups want to be C Corps rather than S Corps, despite the benefits of pass-through taxation, for all the same reasons as switching from an LLC in the first place.
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The Advantages of Converting from an LLC to a C Corporation
The benefits of transitioning to a C Corp from an LLC greatly outweigh any disadvantages for a high-growth startup, especially in the tech industry.
Here are two significant benefits of becoming a C Corp from an LLC. The first being Venture capitalists only want to invest in C Corporations. Because the ownership in the case of LLC is hard to transfer and unpleasant, professional investors prefer C Corps.
Secondly, top talent necessitates the use of stock options. Due to a lack of funding, startups must issue employee equity options to recruit great employees at lower salaries. This is only possible as a C Corporation.
The Disadvantages of Converting from an LLC to a C Corporation
For startups, the tax benefits of an LLC are minor when compared to the advantages of a C Corp. Nonetheless, the conversion procedure can be complex and often costly. The longer you wait the harder it will be. The most significant disadvantage is the conversion procedure itself. There may be no tax on the change itself, but there are exceptions, which could result in significant tax charges. A great accountant and attorney can handle the vast majority of this for you.
If your business was founded as an LLC, and you now wish to change to a C Corp, the basic procedure includes three similar steps.
Whichever method you choose, you will have to create a conversion plan, obtain consent from all of your LLC members, and complete the necessary paperwork. So, to sum up, file a statutory conversion to easily convert your startup from an LLC to a C Corp (following above discussed methods and general steps).
The sooner you make the change the better. Or if you are just starting out, choose a C Corp from the beginning.
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