We help launch dozens and dozens of startups each year. In the vast majority of cases, we form a Delaware C-Corp. However, lately we have seen many startups that formed their own LLC and now need to convert.
Here are the top five reasons you may want to change your company from a Limited Liability Company to a corporation:
1. You want to raise money from VCs. Venture capitalists want to invest in Delaware C-Corps. C-Corps allow investors to create “preferred shares” of stock and provide a consistent legal structure across their portfolios. Some VCs also manage public funds, which are often restricted from investing in LLCs.
2. You want to join a startup accelerator. Accelerators or incubators that take equity often require their participants be incorporated as a corporation. Corporations are comprised of shares of stock, which makes it easy to calculate and distribute equity. Additionally, many accelerators view a corporation as an investment-ready vehicle and a symbol of business acumen.
3. You want to give equity to your employees. In a corporation, it is easy to place shares of stock that the company can later distribute to employees in reserve. In an LLC, the members own 100 percent of the company. In order to give equity to a new member, the members must sell a portion of their personal ownership stake to the new member. This personal sale of securities could trigger capital gains tax and create other complications.
4. You want to issue equity on a vesting schedule. It is relatively easy to issue shares from a corporation that is earned over time on a vesting schedule. In contrast, because there are no shares of stock in an LLC, members usually elect to distribute profit interests. However, defining and calculating those profit interests is an expensive endeavor that requires constant monitoring of member capital accounts.
5. You want to follow best practices. Startups should position themselves to easily accept funding and retain top employees. While it may make sense in some situations to veer off the typical path, doing so usually requires explanation. Founders who want to present themselves as in-line with industry practices seek out corporations.
The process for converting from an LLC to a corporation depends on the state in which you originally formed your LLC. Some states (like Calif.) have a fast-track conversion statute that specifically allows for a domestic LLC to convert to a foreign (out of state) corporation. In other states, a conversion may actually require a merger. In both cases, be sure to consult with a tax expert. You want to consider all tax issues prior to drafting your conversion or merger plan.
The Young Entrepreneur Council, Proud Media Partner of CEO GOLF:
Disclaimer: This article discusses general legal issues, but it does not constitute legal advice. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.
Tucker Cottingham co-authored.