Most startups convert an LLC to a Delaware C corp shortly before their first priced round, or as soon as an investor asks. A Delaware LLC can convert by filing two certificates with Delaware at the same time, and an LLC formed in another state can usually do the same if its home state allows it, or can merge into a new Delaware corporation instead. Most of the legal work is translation: units into shares, profits interests into stock or options, and the operating agreement into a charter, bylaws and stock agreements. The conversion is usually structured to be tax-free, but have a tax advisor review it before anyone signs.
Key takeaways
- Convert before your first priced round, ideally before you sign a term sheet. Waiting can shrink the QSBS benefit.
- A statutory conversion keeps the same legal entity, so contracts, IP and accounts stay with the company. A merger or contribution is the fallback.
- Read the operating agreement first. It sets the vote you need.
- Profits interests convert based on their value at the conversion, not their headline percentage.
- Use the conversion to put founder shares on vesting, assign IP and adopt an option plan.
- The QSBS holding period starts at the conversion, and pass-through losses stop. Ask a tax advisor how it affects each owner.
When should an LLC convert to a C corp?
Usually right before a priced round, or earlier if an investor asks. Venture funds’ own investors include pension funds, endowments and non-US investors, for whom LLC pass-through income causes tax problems, so most funds won’t invest in an LLC. Preferred stock, option plans and the standard financing documents are also built for corporations. See Why Do VCs Require a Delaware C Corp? and C Corp vs LLC.
Waiting has costs that grow with the company. The QSBS holding period starts only when the company becomes a corporation, and value built up in the LLC generally stays outside the QSBS exclusion, so a later conversion leaves more of the founders’ gain unprotected. If the company’s gross assets, measured at fair market value, exceed $75 million at the conversion, the stock issued in it can’t be QSBS at all. Each new member and profits interest grant adds complexity, and converting after a term sheet is signed means doing it on the investors’ timeline. If you plan to raise on SAFEs, convert first, because the standard SAFE is written for a corporation. See SAFE.
What are the ways to convert?
There are three.
| Statutory conversion | Merger into a new corporation | Contribution to a new corporation | |
| What gets filed | Certificate of conversion and certificate of incorporation, together | Certificate of incorporation, then a certificate of merger | Certificate of incorporation, plus transfer documents |
| Same legal entity afterward? | Yes | No. The corporation is the LLC’s successor | No. The LLC becomes a subsidiary, or holds the corporation’s stock after an asset transfer |
| Contracts, IP and permits | Stay with the company, though some permits need updating | Pass to the corporation by law, subject to contract terms and permit rules | Stay in the LLC subsidiary, or must each be assigned |
| What the home state must allow | An LLC converting into a corporation of another state | An LLC merging with a corporation of another state | Nothing special |
| Members who object | Bound if the required vote is met, subject to any dissenters’ rights | Bound if the required vote is met, subject to any dissenters’ rights | Must each agree to contribute units, unless the operating agreement can force them. An asset transfer needs the LLC’s approval |
Statutory conversion. This is the usual route. Under Section 265 of the Delaware General Corporation Law and Section 18-216 of the Delaware LLC Act, a Delaware LLC files a certificate of conversion and a certificate of incorporation at the same time. Delaware treats the corporation as the same entity as the LLC, so its property, debts and rights stay with it without any transfer. Delaware won’t file until the LLC has paid its Delaware taxes through the conversion date.
An LLC formed in another state can convert directly into a Delaware corporation under the same section, but only if its home state’s law lets an LLC convert into an entity of another state, and it must also make the home state’s filing. California, for example, allows it, with its own default vote and dissenters’ rights for members. Some lawyers first convert into a Delaware LLC instead.
Merger. You form a new Delaware corporation and merge the LLC into it, and the merger agreement turns units into shares. This is the route when the home state has no outbound conversion statute. New York’s LLC law, for example, lets an LLC merge with an out-of-state corporation but not convert into one, and a New York member who files a written dissent before the vote can be entitled to fair value in cash. A merger can also trip contract clauses that bar assignment “by operation of law.”
Contribution. The members contribute their units to a new corporation for stock, making the LLC a subsidiary, or the LLC contributes its assets. No special statute is needed, but a contribution of units needs every member to sign on, and an asset transfer means assigning every contract and permit, often with consents. The tax treatment can differ between routes, so show your tax advisor the structure before you choose.
What are the steps?
Get the approval the operating agreement requires. For a Delaware LLC, the conversion is approved the way the operating agreement says. If it’s silent on conversions, its vote for mergers applies, and if it’s silent on both, members owning more than 50% of the current interest in profits can approve it. LLCs formed on or before July 31, 2015 apply that default class by class, unless the agreement says otherwise. Many agreements require a unanimous or supermajority vote, and investors may have consent rights. In New York, the default vote for a merger is a majority in interest of the members.
Adopt a plan of conversion. The plan sets the charter, how each unit converts into stock and who the first directors are. Delaware lets the plan list corporate actions, such as adopting bylaws and an option plan, and treats them as approved once the LLC approves the plan. Most lawyers still have the new board sign a consent for a clean record.
File the certificate of conversion and the certificate of incorporation. The charter looks like any new startup’s, with common stock at $0.00001 par value. If some members have a preferred return or a preference in the LLC, the charter may need preferred stock to carry it over. See Certificate of Incorporation and Par Value.
Set up the board and bylaws. LLC managers don’t automatically become directors. Name the board in the plan, adopt bylaws and appoint officers. See Startup Bylaws and Startup Board Consent.
How do LLC units become shares?
The plan of conversion sets an exact share count for each member. The simplest approach is pro rata, with shares set aside for the option plan. Westaway’s default at incorporation is a pool of 1,000,000 shares out of 10,000,000 authorized, and the same structure works for a conversion.
Example. Ana, Ben and Cara own 50%, 35% and 15% of an LLC. Cara is an angel who paid $150,000 for her units. The corporation authorizes 10,000,000 shares of common stock, issues 9,000,000 in the conversion and reserves 1,000,000 for the option plan.
| Holder | LLC percentage | Shares | Fully diluted |
| Ana | 50% | 4,500,000 | 45% |
| Ben | 35% | 3,150,000 | 31.5% |
| Cara | 15% | 1,350,000 | 13.5% |
| Option pool | 1,000,000 reserved | 10% | |
| Total | 100% | 10,000,000 | 100% |
A pro rata split works only if the operating agreement divides value by percentage. If Cara’s agreement returns her $150,000 before anyone else is paid, a flat 15% of the common stock may give her less than her deal, so the plan should either run the LLC’s distribution waterfall at an agreed value or give her preferred stock with a matching preference. See Why Use Exact Share Numbers and Preferred Stock vs Common Stock.
What happens to profits interests and unvested units?
A corporation can’t have profits interests. The plan usually converts each one into common stock based on what it would receive if the LLC were sold at its value on the conversion date, which can be far less than its headline percentage.
Example. Dev holds a profits interest in 5% of the company’s growth above $2,000,000, the company’s value when the interest was granted. The LLC is worth $4,000,000 at the conversion. Dev’s interest is worth 5% of the $2,000,000 of growth, or $100,000, which is 2.5% of the company. So Dev receives 225,000 of the 9,000,000 shares issued in the conversion, not 450,000, and the other members share the remaining 8,775,000. If the company wants Dev to have more, the usual tool is an option grant from the new pool.
Unvested units usually become unvested stock with the same remaining schedule, which the company can buy back if the holder leaves. Some companies instead swap small profits interests for options, with the holder’s consent. See Alternative Equity Compensation.
Should founders put their shares on vesting?
Investors will expect founder vesting at the first priced round, and the conversion is the cleanest time to set it up. LLC founders often hold fully vested units. A restricted stock agreement puts each founder’s shares on a four-year schedule, usually with credit for time already worked, so a founder who has been building for a year might start with 25% vested. See Vesting Schedule and Restricted Stock Purchase Agreement.
Any stock that is unvested after the conversion raises an 83(b) question. A 2007 IRS ruling treats receiving unvested stock in exchange for vested stock, in a reorganization or a taxable exchange, as a new transfer of restricted stock for which an 83(b) election can be made. It doesn’t address LLC conversions or units that were already unvested, so some advisors have holders of unvested stock file a protective election, which is due within 30 days of the conversion. Whether to file is a question for each holder’s tax advisor. See 83(b) Election.
What else has to move into the corporation?
IP. In a statutory conversion, the corporation keeps everything the LLC owned. But anything a founder built before the LLC existed, or without a written assignment to it, may still belong to the founder. Have each founder sign an IP assignment to the corporation, and have founders, employees and contractors sign a CIIAA with it. Record the conversion with the USPTO for any patents or registered trademarks. See Who Owns Startup IP? and CIIAA.
The option plan. Adopt an equity incentive plan for the reserved pool, have the stockholders approve it, and get a 409A valuation before granting options. See Employee Option Pool and 409A Valuation.
The EIN. The IRS position is less settled than founders expect. Its public EIN guidance says a partnership that incorporates needs a new EIN, but its regulations keep the EIN when classification changes by election, and its internal manual lets an entity that converts under state law with the same structure keep its number. Many advisors treat a statutory conversion as keeping the EIN, often with a letter to the IRS documenting it. A single-member LLC that used its owner’s number needs its own, and a new corporation formed for a merger or contribution generally gets a new one. Decide with your accountant before you tell the bank. See How Do I Get an EIN?
Bank accounts, contracts and permits. Give the bank the filed certificates, the board consent and the EIN confirmation, and update payroll, insurance and customer W-9s. After a statutory conversion contracts continue, but check for clauses that treat a change of entity as an assignment or change of control. Licenses, permits and sales tax registrations may need to be updated or reissued.
Foreign qualification. The corporation registers in each state where it does business, and the LLC’s old registrations are withdrawn or updated. See Do I Need to Foreign Qualify My Delaware Startup?
The final LLC tax returns. For an LLC taxed as a partnership, the tax year ends at the conversion. It files a final partnership return and K-1s for that short year, and the corporation files its own returns from then on. Members still owe tax on the LLC’s income up to the conversion, so check whether the operating agreement requires a tax distribution.
How is a conversion taxed?
These are general descriptions, not tax advice. Have a tax advisor review the structure before anyone signs.
Section 351. For an LLC taxed as a partnership, the IRS treats a statutory conversion as if the LLC transferred all its assets and liabilities to a new corporation for stock and then distributed the stock to its members. Section 351 generally lets people transfer property to a corporation for its stock without recognizing gain if, together, they control at least 80% of the corporation immediately afterward. Liabilities above the tax basis of the assets, cash paid out and stock issued for services can still create tax, and an LLC that elected S corp taxation follows different rules. See S Corp vs LLC.
QSBS. Stock issued in the conversion can qualify if every requirement is met, but the holding period starts at the conversion, not when the LLC was formed. For QSBS purposes, stock received for property takes a basis of at least that property’s fair market value, so the gain built up in the LLC generally stays outside the exclusion. See QSBS (Section 1202).
The end of pass-through losses. An LLC’s losses flow through to its members’ returns. After the conversion, losses stay in the corporation and can offset only its own future income. Members using LLC losses, or holding losses they couldn’t yet deduct, should ask a tax advisor what changes.
How long does it take, and what goes wrong?
A Delaware LLC with a few members and a clean operating agreement can usually convert in two to four weeks, most of it spent agreeing on share numbers and getting tax advice. Out-of-state LLCs, mergers, profits interests and outside investors add time, so start at least a month before you expect a term sheet.
The operating agreement requires a unanimous vote. One member can then block the conversion or hold out for better terms, and amending the agreement usually takes the same vote. Find out early and talk to each member before the formal request.
Members want to keep a profits interest. They can’t, in a corporation. Show each holder the conversion value of their interest and what stock or options will replace it, before the vote.
The home state’s conversion statute. For a non-Delaware LLC, confirm that the home state allows an outbound conversion, what it requires to be filed and whether members get dissenters’ rights.
SAFEs issued by the LLC. The standard SAFE is written for a corporation, so a SAFE issued by an LLC is usually a custom document. After a statutory conversion the obligation stays with the company, but its terms may refer to units and events that no longer exist. Review every SAFE and convertible note, and amend them with the holders so they convert into the corporation’s stock at the next priced round. See SAFE vs Convertible Note.
Checklist: after the conversion is filed
- 83(b) decisions made with a tax advisor, inside the 30-day window
- IP assignments and CIIAAs signed with the corporation
- Option plan approved and a 409A valuation ordered before any grant
- EIN position confirmed with your accountant
- Bank, payroll, insurers, customers and vendors updated
- Foreign qualifications filed and the LLC’s registrations closed out
- Final LLC tax returns and K-1s calendared
- Cap table updated with exact share counts
For more, see C Corp vs LLC, S Corp vs LLC, QSBS (Section 1202), Delaware C Corp Incorporation Documents and our LLC to C Corp Conversion service.
If you’re converting an LLC before a raise, contact us before you ask members to vote.
