Starting your company as an LLC can have significant benefits—including a flexible structure and easy setup—but you may need to restructure as a corporation later on.
Converting from an LLC to a C-corp can make it easier to fundraise, among other things, but the process can be tedious for some companies.
If you’re considering a C-corp vs. LLC, here’s what you need to know:
C-corps vs. LLCs
Both LLCs and C-corps offer business owners personal liability protection from business debts and lawsuits, but the two business types have different ownership structures and tax consequences.
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LLC |
C-corp | |
|---|---|---|
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Structure |
• LLCs can have sole owners or multiple owners (called members). |
• C-corps have a set ownership structure, part of which involves creating a board of directors and agreeing on corporate bylaws. |
|
Equity |
• Members hold equity interests, meaning they receive a percentage of profits based on how much money they invested in the company.• LLCs can’t issue shares to employees, but they can issue what’s called profits interests units. LLCs can also have an unlimited number of members who receive profits. |
• Owners (called shareholders) are issued shares of stock in the company.• Shareholders may be able to sell their shares. |
|
Taxes |
• Company profits and losses are passed through to the individual members.•Members pay taxes on their share of company profits on their personal tax returns.•However, members can also take a C-corp or S-corp tax election. |
•The corporation pays corporate income taxes on its profits and losses.•The shareholders may pay taxes when they sell (and sometimes buy) their shares. |
Why should you convert from an LLC to a C-corp?
Whether or not you convert to a C-corp depends on your business finances, preferred company equity system, and growth goals. Most founders convert from an LLC to a C-corp for two reasons:
1. Better chance of raising venture capital money
It can be difficult to fundraise from investors as an LLC. Unlike C-corps, LLCs have fewer liquidity events (like IPOs and acquisitions), which can make them a riskier choice for investors. To safeguard their investments—and take advantage of more straightforward tax reporting—most VCs prefer to put their money into corporations.
2. Easier to offer employees equity
If you want to extend equity to your employees in an LLC, your options are limited. You can give employees profits interest units, which is a portion of the value the company gains over a certain period of time, but they can be complex to administer.
In a C-corp, there are multiple types of equity you can offer. Offering employees equity in your company is a great way to attract talent, improve retention rates, and set your company up for long-term success.
Before you convert to a C-corp, take the following factors into consideration:
Company goals
Do you want to expand or fundraise soon? Or maybe you want to go public sometime in the next five years? If so, converting to a C-corp could help.
On the other hand, if your goals are more geared toward internal changes, like improving company culture, diversifying your clientele, or increasing sales, converting to a C-corp may not necessarily help you get ahead.
Taxes
Consider what you’d stand to lose or gain tax-wise by converting to a C-corp.
If you’re the sole member of an LLC, you get taxed as a disregarded entity; if you’re one of multiple members, you get taxed as a partnership. In both cases, the IRS considers you self-employed, which means you have to pay Social Security and Medicare taxes based on your business’s net earnings.
In a C-corp, you’re subject to double taxation, which is taxation at both the corporate and shareholder level. As a result, you may end up paying more in taxes as a corporation, despite the fact that LLC members are required to pay self-employment taxes.
However, if you make a C-corp election as an LLC, your LLC gets taxed like a corporation: the business itself pays income taxes at the corporate rate, while the LLC members pay taxes only on the income they receive as a salary or dividend.
Understanding the advantages and disadvantages of tax elections can be tricky, so it’s a good idea to consult a business attorney and accountant to go over your options.
Management style and schedule
One of the benefits of structuring your business as an LLC is the flexibility it gives you with ownership and management. As a sole owner, you can run your company on your own terms. If you’re one of multiple owners, you can oversee day-to-day operations yourself, appoint another member to do it, split duties, or even bring in an outside manager depending on what works for you.
Converting your LLC into a C-corp, however, changes the ownership and management dynamic. In a C-corp, you have to hire a board of directors to oversee funds and set goals; hold meetings for board members and shareholders; and keep investors up-to-date on company KPIs and finances.
On one hand, this setup means you benefit from extra brainpower and deeper pockets; on the other hand, you also have to manage investor expectations, deal with extra admin work, and run decisions by your board of directors, all of which can impinge on your autonomy as an owner.
How to convert from an LLC to a C-corp
There are two main ways to convert your LLC into a corporation: a statutory conversion or a statutory merger. The method you choose depends on the state laws where your LLC is registered.
Let’s take a closer look at the two options.
1. Statutory conversion
A statutory conversion is the easiest and quickest conversion option. With a statutory conversion, you can transfer your LLC’s assets and liabilities to a corporation without having to dissolve your LLC. The LLC’s former members become corporate shareholders and the company’s assets and liabilities belong to the new corporation.
Here’s what the general process entails:
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Create a conversion plan and get it approved by your members
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File a certificate of conversion with your state and pay a filing fee
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File any other relevant documents, like your LLC certificate of formation
Reach out to find out whether or not your state allows statutory conversions.
2. Statutory merger
A statutory merger is more complicated than a statutory conversion, but it can be a good option if your state doesn’t allow statutory conversions. Under a statutory merger, you have to form a separate corporation with your LLC members as shareholders, merge the two companies, then formally dissolve the LLC.
Here’s what the general process entails:
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Form a separate corporation with LLC members as shareholders
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Create a merger plan and ask each member to approve it
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Exchange your membership interests for shares in the new corporation
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File a certificate of merger with your state
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File a formal dissolution of your LLC
If you opt for a statutory merger, it’s important to work with a business attorney to file your documents and ensure you have everything you need.
Post-conversion
Once you convert your LLC to a C-corp, there are a handful of steps you need to take to make everything official:
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Create corporate bylaws
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Elect board members and directors
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Hold board meetings and shareholder meetings
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Issue stock certificates
Converting from an LLC to a C-corp may seem daunting, but it can be a great option if you want to offer employees equity or fundraise more easily. Just make sure you consult a business accountant and lawyer to go over your options and help facilitate the transition.
