The How and Why of Corporate Conversion

Corporate Conversion
Many LLCs desire to convert their corporate form to a C-Corp

Limited Liability Companies (LLCs) are habitually the preferred corporate structure for startups and small business owners. In many ways, they are also the most practical form for small companies who do not need or seek outside investment and do not envision significant growth.  An LLC is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

Conversely, a C Corporation (C-Corp) requires small business owners to plan ahead at the initial stages of formation such that stock authorization; board of directors; determining the relationship between the company and the stockholders; and other critical decisions are at the very forefront of setting up the corporation. A C Corporation is the most common type of corporation because it offers unrestricted growth capability via stock sales which in turn means outside investors and venture capitalists find this arrangement more attractive, in most scenarios.

Many companies that are currently organized as an LLC have difficulty seeking outside investment simply because of their entity’s outfit.  An LLC structure makes it very challenging to bring in fresh management because the LLC is arranged so that the original owners (Members) comprise the entire pie, i.e. 100% of equity has already been distributed. A C-Corp has the inherent flexibility to bring in new management and advisors without an ownership transformation or an equity stake reduction.  A C-Corp allows an indefinite amount of stockholders; different classes of shares; and the ability to control the rights of certain shareholders.

For those reasons, many LLCs desire to convert their corporate form to a C-Corp.  In many instances, LLC owners are told by outside investors that they must convert their entity before the investor will truly consider making an investment.  An LLC can convert either to a domestic C-Corp (e.g. a Texas LLC will become a Texas C-Corp) or, alternatively, the LLC can convert to a Delaware C-Corp.

Converting Your Texas LLC to a Delaware C-Corporation

There’s a reason I learned Delaware corporate law in my New York Corporations course in law school.  Delaware General Corporation Law is the most advanced and accommodating corporate statute in the nation which includes Delaware’s pro-business court, the Court of Chancery.  Delaware’s corporate statutes were deliberately constructed to give as much as flexibility to the corporation and the statute plainly allows the corporate vehicle to run fluently and without countless regulatory impediments.

The process of converting your Texas LLC to a Delaware C-Corp is not as complicated as it may seem.  You must first file a Certificate of Conversion (Foreign-LLC to Delaware Corporation) Form (Link here: Delaware Corporate Forms) and include Delaware’s standard Certificate of Incorporation Form which delegates the makeup of your new Corporation.  You may either compute your filing fees based on Delaware’s corporate fee system (Link here: Delaware Fee Information) or you can simply include credit card information and have the Delaware division determine your fees and invoice you directly.  Once you’ve completed that task, you must file the Texas Certificate of Conversion with the Texas Secretary of State in order to terminate the Texas LLC (More info here: Texas Merger and Conversion FAQs).  A requirement to this filing is that you include a Certificate of Account Status from the Texas State Comptroller of Public Accounts which indicates that all franchise taxes have been paid and franchise tax reports have been filed.  There is a flat $300.00 fee to submit the Texas certificate of conversion.

Converting Your Texas LLC to a Texas Corporation: The Texas Conversion Statute

The Texas Secretary of State’s office offers a simplified method of converting a Texas LLC to a Texas corporation.  This process is known as a “statutory conversion” and will automatically convert the LLC to a corporation.  This is a favorable method as you will not have to independently convey your LLC’s assets and liabilities to that new corporation.  Unlike the process of converting a Texas (or foreign) LLC to a Delaware Corporation, there is no need to set up a corporation separately, i.e. you do not need to file a certificate of incorporation.  As a result of the statutory conversion, the LLC transforms into a corporation making it unnecessary to dissolve the previous entity.

The Texas Conversion Statute is detailed in Chapter 10 of the Texas Business Organizations Code (Link here: CH. 10: Texas Mergers & Conversions).  To convert a Texas LLC to a Texas corporation, the following must be done: (i) file a certificate of conversion including a certificate of account status with the Secretary of State; (ii) file a certificate of formation with the Secretary of State; and (iii) adopt a plan of conversion and file it with the Secretary of State.

Why Convert?

As suggested above, a corporation signifies an investment-ready operation.  Venture capitalists desire, and often require, to invest in Delaware C-Corps because this structure permits investors to pursue and attain “preferred shares” of stock.  In an LLC, the members own 100 percent of the company – therefore, in order to give equity to new members, the original members must sell a portion of their personal ownership stake to the new member.

Whatever the case may be, we highly encourage you to consult with your CPA or tax advisor so that you can fully comprehend the tax implications of the corporate change.

Brett H. Pavony and the attorneys at De Leon & Washburn, P.C. are available to assist clients with corporate matters. For more information regarding the firm’s practice areas, please visit our Practice Areas page, and please feel free to contact the attorneys at any time.

© De Leon & Washburn, P.C. This article is provided for informational purposes only. It is not intended as legal advice nor does it create an attorney/client relationship between De Leon & Washburn, P.C. and any readers or recipients. Readers should consult counsel of their own choosing to discuss how these matters relate to their individual circumstances. Articles are not continuously updated, and D&W makes no warranty or representation regarding accuracy or completeness.