by Ethan Stone, Stone Business Law
I have a California LLC, and I’m planning on converting to a Delaware C Corporation in anticipation of funding. What should I consider when making this type of conversion? And what do I need to do to get it done?
First, a quick but important clarification: I’m not your lawyer and this answer doesn’t establish a lawyer-client relationship. I’m giving a generic answer to a generic question to educate the users of this site. The information below is general in nature and should not be understood as a substitute for personal legal advice.
Second, although the process of converting a California LLC to a Delaware corporation is not very complicated, it isn’t a DIY project. You should get a competent lawyer to carry it out for you, since various consents, plans and state filings need to be prepared, signed and filed to get it done right. I’m assuming you’ll be represented in your VC financing, so this won’t be an issue. Accordingly, I’m also going to skip a lot of nuts and bolts detail (e.g. the need to adopt a “plan of conversion” and the elements it has to contain) and give you a general overview.
The good news is that it’s usually a very straightforward process. Both California law and Delaware law allow an existing California LLC to convert into a Delaware corporation, simply by taking a vote of the members and making some filings with the secretaries of state of California and Delaware. Under both California and Delaware law, the company just continues on in a different form. It’s not a new entity. You’ll need to allow some time to get the paperwork done, approved by the members and filed. Both Delaware and California offer expedited service for a price. You pretty much have to pay the price to get anything done on a reasonable schedule in California and even then, the fastest turnaround they’ll promise is 24 hours (which I wouldn’t count on). Your counsel can help you come up with a realistic timeline, but it should be doable in a few days, if absolutely necessary.
Bear in mind that you should ask your counsel to review your significant contracts before you carry out the conversion to make sure that converting doesn’t require you to give notice to the other party or give the other party any contractual rights (e.g. the ability to terminate). That isn’t commonly the case, but it depends entirely on how the contract is worded. So unless you’ve been keeping track all along (a good idea), you won’t know until you take a look.
Normally, there are few if any tax consequences to converting an LLC to a “C” corporation. That doesn’t mean that you should forget about it. Although it’s unlikely that you would incur major tax liabilities in the process, there are significant tax planning possibilities in certain circumstances, so you should always check in with a tax lawyer or accountant at the beginning of your planning. The details are far too complex and rare to discuss in detail, but here are some circumstances that might indicate complications: (1) there is a significant difference between the LLC’s tax basis in its assets and the members’ tax basis in their membership interests, (2) the LLC has significant inventory or cash, (3) the LLC has significant taxable income in the period from the beginning of its tax year (usually January 1) to the date of the conversion, (4) the LLC has significant debt, preferred membership interests or has issued options to buy membership interests.
I hope that helps. Good luck with the conversion (and the financing)!