Recently there seems to have been a spate of clients looking to convert from LLC status to regular “C” corporation status. I think of this as the other end of the funnel. Someone formed an LLC, usually on the advice of their accountant (but not always) or they asked a question along the lines of “how hard is it to change later?” To which the answer is “Not very.” They expected to get the tax benefits of a pass through entity (see my prior blog on this topic). And that may be as much thought as went into the process. Well the evil day finally arrives and it is time to convert, what exactly do you have to do and how much will it cost?

First, you have to ask if there are any interesting tax issues. A conversion from LLC to “C” corporation can usually be accomplished without triggering any income tax for the owners or the company, but issues may arise. One that leaps to mind is to find out if the conversion from LLC ownership units to shares of stock in the new company will be exactly pro rata in accordance with the LLC capital accounts. If the answer is yes, then you are off to the next level. If the answer is no, then you need to talk to a tax professional. If the answer is somewhere in between yes and no, perhaps along the lines of “we intend to do a little restructuring” then you need to talk to a tax professional. Another tax problem could arise if the conversion is a preliminary step to facilitate a sale of the company to another company in a tax-free exchange for shares of the acquiring company. If the acquisition is already under negotiation, it may be too late to accomplish the preliminary conversion tax-free. Also, you need to be alert to other possible tax issues. For example, if the conversion does not occur at the end of a taxable year, you may have a stub period to deal with. Again, it would be a good idea to talk to a tax professional.

Second, once you have cleared out any tax issues or figured out how to deal with them, you are onto mechanical things. It turns out that there are more of those than people normally imagine. The LLC has to go through its approval process which may involve a vote of the members. You will need a new corporation with a charter. This can be simple or complicated. For example, will you have just common stock or will you need two or more classes of stock?

You will need a certificate of conversion (assuming a Delaware LLC is becoming a Delaware corporation) or other documentation if you are not operating exclusively under Delaware law. You may also have other concerns that range from stock options to buy/sell agreements to rights of first refusal, to board representation. All in all, what sounded simple turns out to be complex and to cost a lot more than you originally counted on. 

So, one final question: Did you reap any of the benefits of being an LLC? Answer: in my experience many do not.