Converting LLC to C-Corp in Delaware

Most startups that raise venture capital will need to convert from an LLC to a C-corp. The process is manageable if you plan the timing and tax implications correctly.

Why Convert in the First Place

The most common trigger is a venture capital term sheet. VCs invest through funds structured as limited partnerships, and these funds need to invest in C-corporations for several reasons. Pass-through income from an LLC creates unrelated business taxable income (UBTI) for tax-exempt limited partners like endowments and pension funds. LLCs also cannot issue preferred stock with the governance provisions that standard venture deals require. Beyond VC requirements, some founders convert because they want to implement a stock option plan (incentive stock options under IRC Section 422 are only available to corporations) or to qualify for QSBS treatment under Section 1202, which requires a C-corporation.

Three Methods of Conversion

The most common method is a statutory conversion under Delaware law (Section 265 of the DGCL). The LLC converts directly into a corporation by filing a certificate of conversion and a certificate of incorporation with the Delaware Division of Corporations. The entity retains its EIN and contracts, and the membership interests convert into shares of stock by operation of law. The second method is a statutory merger, where a new C-corp is formed and the LLC merges into it. This is sometimes used when the conversion needs to be structured as a tax-free reorganization. The third method is an assets-over contribution, where the LLC contributes all assets and liabilities to a new C-corp in exchange for stock, followed by a liquidation of the LLC. Each method has different tax implications and should be chosen based on your specific circumstances.

Tax Implications to Watch

A statutory conversion is generally treated as a tax-free incorporation under IRC Section 351, provided the former LLC members receive at least 80% of the stock of the new corporation in exchange for their membership interests. If the LLC has liabilities in excess of the tax basis of its assets, the conversion can trigger gain recognition. If the LLC has elected to be taxed as a partnership, the conversion is treated as a contribution of assets to a corporation under Section 351, which requires careful tracking of built-in gains on individual assets. Any accumulated depreciation recapture under Section 1245 or 1250 must be considered. If the LLC is a single-member LLC treated as a disregarded entity, the conversion is simpler because there is no partnership tax return to terminate.

Step-by-Step Process

First, adopt an LLC resolution approving the conversion with the required member vote. Second, work with your attorney to draft the certificate of incorporation for the new corporation, including the authorized share structure. Third, file the certificate of conversion and certificate of incorporation with the Delaware Secretary of State. The filing fee is $214 ($89 for the conversion and $125 for the incorporation, plus any additional authorized shares fees). Fourth, adopt corporate bylaws, appoint initial directors, and hold an organizational board meeting. Fifth, issue stock certificates or book-entry shares to the former LLC members based on the conversion ratio. Sixth, file IRS Form 8832 if needed to elect corporate tax treatment, and update your EIN records with the IRS.

Timing Matters

Convert before the valuation increases significantly. If your LLC is worth $50,000 today and will be worth $5,000,000 after a funding round, the tax friction of converting at $50,000 is minimal. At $5,000,000, complications multiply. The 83(b) election must be filed within 30 days of receiving the restricted stock in the new corporation if the shares are subject to vesting. The entire conversion typically takes two to four weeks, including filings, document preparation, and the organizational board meeting. Plan for at least six weeks before a planned fundraise to give yourself a buffer for any issues that arise.

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Converting an LLC to a C-Corp: When, Why, and How