How to Convert Your Startup From an LLC to a Delaware C-Corp

Yep. It’s a pretty awkward feeling when you find out you need to be C-Corp but you’re just a lowly LLC. Now, there’s nothing inherently wrong with an LLC, but in the world of startups – you want to be a C-Corp. Not an LLC. Not an S-Corp. Believe it our not, the main triggering event that brings most of Savvi’s clients in the door is they need to do an LLC to C-Corp conversion. The founder of a startup has validated their product, gotten their first few customers and is now entering an accelerator or about to raise funds and they found out they need to be a C-Corp. They initially chose an LLC because of the simplicity and pass-through taxation, but now they have to convert. 

Rest assured, conversion isn’t the end of the world and we do many of them. 

The process is quite complex and unique to each company, but in this guide we’ll simplify the main points and get into the nitty gritty where appropriate. 

How do you convert from an LLC to a C-corp?

So, we get it: it’s complicated. It’s complicated because of the variability of the process. There are three main factors to consider, the ones outlined in the video. 

• Value of assets
• Amount of debt
• Diversity of classes of ownership. 

As assets and debt increase, the tax implications of the conversion become increasingly intense. Same with the diversity of classes of ownership. 

On top of those, consider these other variables.

• Tax status of the LLC
• Type of the corporation
• States in which the entities are filed
• Maturity of the LLC

Even with this variability, the process can be broken down into three general steps. 

1. Understand the tax status of your LLC
2. Choose your conversion method
3. Form the new C-Corp

Let’s dive in. 

Understand the tax status of your LLC

With legal entities, there are always two ways to categorize them: 1) how they are formed, 2) how they are taxed. When you formed your LLC, you elected a tax status. The tax status of your LLC has major implications on the type of conversion you should choose. 

There are 3 different tax statuses for LLCs:

1. taxed as a corporation
2. taxed as a partnership
3. taxed as a disregarded entity

By default, an LLC with more than one owner, a multimember LLC, is taxed as a partnership, and an LLC with only one owner, a single member LLC, is taxed as a disregarded entity. These are the two most common types of taxation. One of the main reasons people form as an LLC is to be taxed as a partnership and enjoy pass-through taxation. 

On some rare occasions, an LLC will elect to be taxed as a corporation. Usually, people do this if they are not distributing profits out to LLC members and want to take advantage of the lower corporate income taxes. 

Choose from Three Conversion Methods

The available conversion methods vary from state-to-state, and the paperwork and process for each method depends on the state. The most common conversion for a startup is from a California LLC to a Delaware C-Corp. 

There are three primary conversion methods

• Statutory Conversion
• Statutory Merger
• Nonstatutory Merger

The methods vary, but the general steps are similar. 

1. Develop a conversion plan.
2. Get approval from all of your LLC members or meet the minimum voting requirements in you Articles of Organization. 
3. File the correct forms with the Secretary of State’s office.

How to do a Statutory Conversion

Statuory conversion is a relatively new, streamlined method that converts your LLC into a C-Corp. It converts LLC members to stockholders and converts your LLC’s assets and liabilities to your C-Corp.

This is the easiest and cheapest option, but it isn’t available in all states

Here are the general steps for statutory conversion. 

1. Prepare a plan of conversion 
2. Get it approved by the LLC members
3. File a certificate of conversion and other necessary documents, possibly including LLC certificate of formation, with the secretary of state.

One of the reasons this is easier than other methods is because no formal assignment agreements are required for the conversion to take place.

Most startups that come to Savvi.Legal we are able to convert through statutory merger.

How to convert by a Statutory Merger

In a statutory merger, a C-Corp is formed and it then absorbs the LLC. The LLC members’ interests convert to stock in the new corporation. This is a more formal process than a statutory conversion. 

If your state doesn’t allow statutory conversion, this is the next best option. 

Here are the basic steps. 

1. Form a new C-Corp with your LLC members as the corporation’s stockholders. 
2. The LLC members vote to approve the merger. They must do this in their roles as LLC members and as corporation stockholders.
3. The LLC members formally exchange their membership rights for shares in the corporation.
4. File a certificate of merger and other legally required documents with the secretary of state.

How to convert with a Nonstatutory Conversion

In nonstatutory conversion, you create a C-Corp and then all the LLC members’ interests, assets, and liabilities are formally assigned by specific legal assignments to the C-Corp. 

This is the most messy and time consuming of the three. It is a last resort and is normally only used if you’re in a state that doesn’t allow statutory conversion or statutory merger. If you’ve ever been brave enough to try doing this yourself, we’d love to hear from you. 

Here are the general steps. 

1. Form a new C-Corp
2. Formally transfer members’ LLC’s assets and liabilities to the corporation
3. Formally arrange the exchange of LLC membership interests for corporation shares
4. Formally liquidate and dissolve the LLC.

If this is your only option, your in for a wild ride. 

3. Finish forming the new C-Corp

The conversion process is the most complicated step of this process. But once that is done, you aren’t quite finished. You still need to finish forming your C-Corp. In the conversion, you only created the C-Corp and assigned some shares. You still need to do the other routine tasks required for fully forming a C-Corp. In brief, these include: 

• File articles of incorporation with the Secretary of State of Delaware
• Get a new EIN
• Draft and adopt your bylaws 
• Elect officers and directors
• Hold, or probably waive, an initial board and shareholder meetings
• Issue stock certificates

Once you get these final tasks done, you’ll be well on your way. 

Sidenote: one of the variables in the conversion process is the tax status of the corporation. A corporation can be either an 

• S-Corp which have pass-through taxation, or
• C-Corp which have double taxation. 

Startups don’t want to be an S-Corp, even though they enjoy pass-through taxation; they want to be C-Corps. 

This is all a lot to take in. Let’s consider a couple of examples. 

(Need help with your C-Corp taxes? We love Tanalytics.)

Examples

Arizona

Ben and Jae form their new startup, GoodBye, an app that makes it easy to break up with your girlfriend, as an LLC in their home state of Arizona. They reach 1 million free users and decide to raise a round. Their VC says she’ll only invest if they convert to a C-Corp so she can have risk-free shares. They’re bootstrapping, so at first they hope to do the conversion themselves, but they soon find out Arizona doesn’t allow for statutory conversions, so they’ll need to pull off a statutory merger. This sounds really difficult so they hire an attorney. 

The attorney forms a new C-Corp, and gets the LLC members, Ben and Jae to approve the merger. Ben and Jae then exchange their membership rights for shares in the corporation. The attorney then files a certificate of merger with the Secretary of State. He then finishes setting up the new C-Corp and the conversion is over. 

Ben and Jae raise their first round. 

California

Let’s see how it plays out differently in California. 

Ben and Jae are trying to raise a round again, but this time they’re in California. California does allow for a statutory conversion. 

This time, the process is easier but they still hire an attorney, just to be safe. The attorney gets approval for the conversion from Ben and Jae. He then files GoodBye’s Articles of Incorporation with a statement of conversion. The conversion is complete. Ben and Jae raise their round. 

The Advantages of Converting to a C Corp

For a high-growth technology startup, the upsides of converting to a C-Corp far outweigh any downsides. Here are two key reasons to convert. 

• VCs only invest in C-Corps. LLC ownership is difficult to transfer and awkward, and for a number of reasons, professional investors prefer C-Corps. 
• Top talent requires stock options. Startups have limited cash, so they need to issue stock options to attract top talent at lower wages. This can only be done as a C-Corp. 

The Disadvantages of Converting to a C Corporation

The tax benefits of an LLC are negligible compared to the benefits of a C-Corp for a startup; however, the process to convert is complicated and is usually costly. The main disadvantage then is simply the conversion process itself. No tax applies specifically to the conversion itself, but exceptions do apply and there could be a large tax bill at the end. 

Sum-up

If you’re a startup formed as an LLC, you need to convert to a C-Corp. 

This is the basic process. 

1. Understand the tax status of your LLC
2. Choose your conversion method
   • Develop a conversion plan
   • Get approval from your LLC members 
   • File the correct forms
3. Finish forming the new C-Corp

With Savvi.Legal clients, this is how it usually plays out. The founder comes to us to convert; the startup is being taxed as a partnership; we file a statutory conversion and convert it to a DE C-Corp. The devil in this process is actually in the legal tax work, and this is where the bulk of the cost sits. The legal paperwork itself is often straightforward.

What Savvi Will Do For You

So, like we said, this is a complex process. Some brave entrepreneurs can surely accomplish this themselves. But, this is the most common reason startups come to us. And we can make it simple for you. 

There are lots of ways to get legal work done, but in our view Savvi is the best. At Savvi, we provide the perfect blend of automated and bespoke legal services to make startup legal work easy. Savvi helps founders get legal work done quickly and properly so they can sleep well at night and get on to doing what they do best: building their business.

Savvi can do this whole process for you.

(We can also hook you up with free Carta.)

FAQ

How does the IRS view Transfers of Assets and Interests?

Earlier, we didn’t completely exhaust the topic of nonstatutory conversion. The IRS see three methods of nonstatutory conversion. 

• “Assets-over” conversion. It’s called “assets-over” because assets are transferred “over” to the new C-Corp. In this method, the LLC transfers all of its assets and liabilities to the new C-Corp in exchange for all outstanding stock. Then the LLC is dissolved by distributing all of the corporation’s stock to the LLC members. 
• “Assets-up” conversion: It’s called “assets-up” because first assets are transferred down from the LLC to its members and then back up to the new C-Corp. So, the LLC distributes all assets and liabilities to its members and is then dissolved. The members then transfer all the assets received from the LLC to the C-Corp in exchange for all outstanding stock of C-Corp plus the corporations assumption of the former LLC’s liabilities.
• “Interests-over” conversion: This one is called “interests-over” because the LLC members transfer their interests over to the new C-Corp. So this is similar to the first, but this time LLC members transfer their interests in the LLC to the corporation in exchange for all outstanding stock. This terminates the LLC and assigns assets and liabilities to the C-Corp. 

(Go here for the official IRS document.)

The IRS has stated that it will treat statutory conversions and mergers as an assets-over conversion. 

Each type of conversion has its own tax consequences. 

(This book could be helpful, if you’re into that kind of thing: Federal and State Taxation of Limited Liability Companies.)

Conversion to an S-Corp?

If you want to convert an LLC to an S corp, just file form 2553 with the Internal Revenue Service. 

Can I turn my LLC into a corporation?

Yes, you can. However it may be expensive depending on the size of the corporation. There is nearly always a way to convert from an LLC to a corporation. 

Can LLC file as C Corp?

Yes. LLCs get to choose how they are taxed: as a partnership, a sole proprietorship, or a C-Corp. 

Can a single member LLC elect C Corp status?

Yes, same as above. LLCs get to choose how they are taxed: as a partnership, a sole proprietorship, or a C-Corp. Just file IRS Form 8832.

Should my business be a corporation or LLC?

If you are a high-growth technology startup, you should be a Delaware C-Corp. Savvi caters to these types of companies. If you’re a regular small business, it might make sense to be an LLC. If you’re a startup that’s already formed as an LLC, it’s not too late; you can still convert to a C-Corp.  

Why should an LLC file Form 8832?

File an IRS Form 8832 – Entity Classification Election to choose your tax status. You can choose to be taxed as a corporation, a partnership, or a sole proprietorship. 

What is a statutory conversion?

Statutory conversion is the process of changing the type of an entity or moving it to a different state. Most states allow statutory conversion. It is literally converting the entity by allowance of a statute.  Here is the official california code dealing with statutory conversion.

How much does it cost to convert from an LLC to a C-Corp? 

Law firms charge a lot to convert your startup from an LLC to C-Corp. The very low end starts at $3000. Savvi.Legal can do this process for just $2000, plus we can defer payment till after the close of a fundraising round. 

How do I manage my DE C-Corp cap table?

There’s a few good ways to manage a cap table out there, and a lot of bad ways. Cap table refers to your capitalization table. This is essentially a glorified and uber-important spreadsheet where a company records its equity capitalization – so it shows who owes how much of the company. This may seem trivial in early stage companies, but it is not. Soon, that 0.01% will become a million dollars and then everyone wants to make sure the cap table is managed properly. We get all of our companies set up on Carta, the best of the best for cap tables (early stage companies for free).

What is a statutory merger or consolidation?

In a statutory merger, two companies merge, but one company keeps its own legal identity after the merger. In the case of conversion, LLC merges with the C-Corp and the C-Corp keeps its identity. Just like statutory conversion, it’s enabled by statute. Here’s the official statute in Missouri.

Do shareholders have to approve a merger?

When using a merger as an instrument to convert from an LLC to a C-Corp, it’s best to get approval from all the members and shareholders. 

Are mergers same as acquisitions?

No. In the case of conversion, merger is slightly different than acquisition. 

Is conversion the same as changing Tax Status? 

No. In this guide we’ve focused on converting from an LLC to C-Corp, as that is a common request from startups. It is different from simply changin tax status. To change the tax status of your LLC, do one of the following. 

• File IRS Form 8832 to be taxed as a C corporation
• File IRS Form 2553 to be taxed as an S corporation 

This is a fairly straightforward “check-the-box” process. It does involve special eligibility criteria. Usually, you’ll be eligible, but you can see the instructions on the forms.

Do I need an accountant to handle the taxes for my DE C-Corp?

If you want to be compliant, yes. The good news is: we don’t live in the 1990s. That means that some accounting firms are creating awesome cloud-based accounting software that can help you be compliant without all the expense. Tanalytics is at the top of our list.