The business structure that made sense for your startup several years ago might not be the best choice for the next chapter. This tends to be especially true for a startup that initially formed as a limited liability company (LLC) to save time and compliance headaches, but now wants to do all the fun things a C-corporation can do—things like raising venture capital money and offering equity compensation to employees in a standardized way. 

The good news is that flipping from an LLC to a C-corp is totally possible (in most states), and not all that uncommon. The sort-of-bad news is that it costs money and involves some tax consequences that can feel painful if you aren’t prepared for them. Before forming a new corporation, you’ll also want to understand the various ways in which C-corps differ from LLCs and double-check the requirements for entity conversion in your state. Some states (hello, Delaware!) make it easier than others.

With that preamble out of the way, let’s get into the good stuff. Here’s everything you need to know about how to convert an LLC to a C-corp.

• Should I convert my LLC into a C-corp?
• How do I convert an LLC to a C-corp?
• Are there state-specific guidelines for converting to a C-corp?
• Pulley helps at every stage of your startup’s journey

Should I convert my LLC into a C-corp?

Forming a C-corp can be an expensive process, and it doesn’t make sense for every business. But if you’re an ambitious startup founder intent on raising money from investors and one day going public, you may not have much of a choice. 

C-corps have several built-in advantages over LLCs:

• Venture capitalists will invest in C-corps but usually not in LLCs. This has a lot to do with how C-corps and LLCs are taxed. LLC taxation is a bit of a deal-breaker for VC investors, because LLC members are taxed on gains even if they aren’t paid a distribution. Shareholders in a C-corp, on the other hand, are only taxed on shares when they sell or receive a distribution, such as a dividend. Does it make sense for investors to pay taxes on gains if they aren’t seeing any money? Not really.
• C-corps can offer equity compensation to employees—LLCs can’t. C-corps can issue stock, which is good for attracting both investors and cream-of-the-crop employees. LLCs can only offer something known as profits interest (i.e. the right to receive a percentage of future profits) as a sort of counterpart to stock options, but this may not look as attractive to prospective employees. 
• C-corps may offer better international legal protections for startups with global ambitions. LLCs can be great when you’re operating in a single jurisdiction, but corporations tend to offer better legal protections if you operate in multiple states or countries. International jurisdictions generally understand how C-corps work, and they may not give an LLC the same tax benefits they get in the U.S. 

It’s worth noting that both LLCs and C-corps offer similar limited liability protection. This means that, in both cases, business owners are generally protected from being personally liable for any debts and obligations the business incurs. So, if your only reason for converting to a C-corp is to shore up your personal liability, it may not give you much of an advantage over an LLC.

Does converting to a C-corp come with any disadvantages?

Well, there may be a few. 

For one, C-corps generally face stricter regulatory requirements than LLCs. After filing articles of incorporation, you’ll need to create a set of corporate bylaws, elect a board of directors, hold board and shareholders’ meetings, and issue your first shares of stock. 

This can be a lot of work if you aren’t prepared for it! But it’s not always as bad as it sounds. These days, services such as Clerky are available to help hapless founders with templatized documents and guided walk-throughs.

C-corps also have a relatively inflexible management structure, thanks to the presence of a board of directors and corporate bylaws. While this means they can be more difficult to operate, it’s not entirely accurate to call it a disadvantage. In fact, a strong and stable management structure can be a real strength for your startup as it grows, and an advantage when it comes to pitching new investors. 

The real disadvantages about converting to a C-corp tend to involve certain tax issues. It’s worth unpacking these in a dedicated section, so let’s go ahead and get our hands dirty.

What are the tax implications of converting from an LLC to a C-corp?

A key difference between an LLC and a C-corp involves taxation. 

Unlike an LLC, which can “pass through” taxes to individual LLC members and thus avoid corporate taxes, a C-corp is taxed separately from its owners. This means that its revenues may be subject to “double taxation.” In other words, the corporation must pay income tax on its earnings and the shareholders must also pay tax on dividends distributed and reflected on their personal tax returns. Double the taxes, but not double the fun. (The good news is that corporations may be able to qualify for some deductions and tax benefits that somewhat ease their tax burden.)

You may also be hit with extra taxes related to the process of conversion. Under U.S. Code 351, the IRS allows the transfer of an LLC’s assets and liabilities to a corporation without recognizing gains or losses. But there are some complexities here that may require a tax expert to navigate, and certain cases in which you may be hit with a tax penalty upon conversion. 

One last thing to note is that LLCs aren’t all treated the same for tax purposes. Some LLCs are taxed as partnerships, some opt to be taxed as corporations, and some may be taxed as disregarded entities. The tax consequences of converting from an LLC to a C-corp may differ depending on your LLC’s tax status, which is another good reason to find an attorney who can guide you through the process.

How do I convert an LLC to a C-corp?

So, you’ve decided to convert your LLC to a C-corp. How do you actually do it? The first step in the conversion process is to choose the type of conversion you want to do. 

There are three types to choose from: a statutory conversion, a statutory merger, and a non-statutory conversion. The statutory conversion is typically the simplest and least expensive way to go about things, but it may not be available to you depending on where you decide to incorporate. In that case, you may need to consider one of the other two options.

Statutory Conversion

A statutory conversion is a streamlined conversion option available in some, but not all, states. This process may differ depending on the specific regulations provided at the state level, so you’ll want to get in touch with the relevant Secretary of State’s office to confirm what you need to do. 

In general, a statutory conversion involves the following:

• Creating a plan of conversion and getting it approved by your LLC membership. 
• Filing a certificate of conversion with the relevant jurisdiction’s Secretary of State’s office. Here’s an example of a certificate of conversion for a Delaware C-corporation (likely the kind you’ll be forming if you want to attract VC investment)
• Filing articles of incorporation and completing any additional necessary steps required by the state that oversees corporate filing.

A statutory conversion essentially converts LLC members into stockholders and also converts the LLC’s assets and liabilities into the C-corp’s assets and liabilities. 

Statutory Merger

As its name implies, a statutory merger effectively merges the existing LLC with a newly created C-corp. This is probably your best bet if the relevant state laws do not support the above option of a statutory conversion.

A statutory merger is a bit more complicated than a statutory conversion, because you technically need to form the new C-corp before you do anything else. Once it’s formed, your existing LLC members (who also happen to be stockholders in the new corporation) can approve a merger between the two and convert their LLC membership rights into shares of stock in the new corporation. 

You may also need to file a certificate of merger with your relevant Secretary of State in order to complete the process. Here’s an example of a certificate of merger, courtesy of the great state of Texas.

Non-statutory conversion

A non-statutory conversion is generally considered to be less desirable than the two aforementioned options. Like the statutory merger, it requires forming a new corporation prior to the actual conversion event. After that’s done, the LLC’s assets and liabilities can be transferred to the C-corp and membership rights can be converted into shares of stock.

Both of these steps—the transference of assets and liabilities and the exchange of membership rights for stock—involve additional agreements and steps that can complicate matters somewhat. Before opting for this route, speak with your tax attorney to see if you may qualify for one of the more streamlined conversion types. 

Are there state-specific guidelines for converting to a C-corp?

Different states may have different guidelines and regulations around converting from an LLC to a C-corp. That’s why it’s important to check with the local Secretary of State’s office before moving forward with a conversion.

The good news is that Delaware—the state where startups are most likely to convert to a corporation—generally makes the process pretty easy. When converting an LLC to a Delaware C-corp, you’ll be able to complete a statutory conversion by completing and submitting the appropriate forms.

Pulley helps at every stage of your startup’s journey

LLC owners may be loath to give up some of the tax benefits associated with their business entity’s status, but converting to a C-corp can open up a ton of doors for a growing startup. In cases where VC and/or other private equity investment is necessary for growth, converting may become inevitable.

Founders starting a new business should also think long and hard about their ultimate goals before settling on an LLC vs. C-corp. Pass-through taxation can be a nice benefit in the short term, but converting an LLC to a C-corp costs money, too.

All of this may seem a bit overwhelming, but Pulley is here to make your life as a founder easier. Whether you’re founding a new business or flipping an LLC to a C-corp, our tools and experts are here to help. For example, Pulley’s cap table management platform makes it easy for newly created corporations to keep track of the equity they issue and avoid costly mistakes when raising money from investors. 

Ready to take the next step? Schedule a call with our team today.