Yep. It’s a pretty awkward feeling when you find out you need to be C-Corp but you’re just a lowly LLC. Now, there’s nothing inherently wrong with an LLC, but, in the world of startups – you want to be a C-Corp. The process of converting is quite complex and unique to each company, but in this article, we’ll address the main considerations at hand.
Consideration #1 – Why convert?
LLC’s are great for small businesses that intend to stay small because they boast great tax incentives. But if a startup is wanting to grow, it’ll need to convert to a C-Corp. Here are the top three reasons we’ve found for why it’s important to convert:
1. Founders can benefit from QSBS treatment (Rule 1202) for their equity (must hold for 5 years, only applicable to C-Corp qualified small businesses).
2. Granting equity to team members is much easier in a C-Corp (no K-1s, no profits interests, option grants are typically very straightforward and can get ISO treatment, etc.).
3. Businesses essentially HAVE to be a C-Corp to receive VC investment. LLCs can never go public, which is one of the few possible ways that a VC can actually get a return on their investment.
Consideration #2 – What potential drawbacks exist in converting?
Inability to pass through net operating loss (NOLs) to founders to offset other tax liabilities in a C-Corp.
Entity-level taxation at a C-Corp (often called “double taxation”). LLC’s are a type of “flow-through entity,” which means that all profits are given directly to shareholders. Because of this, the money is only taxed as income once, when it is received by the shareholder. Profits made by a C-Corp, on the other hand, are taxed as income both at the corporate level and the shareholder level.
Complicated cap tables (profits interests, etc.) can make converting into a C-Corp very complicated and messy.
Consideration #3 – When would these drawbacks affect me and my startup?
Head to Savvi to read our responses to these concerns and find out! Savvi is a lifecycle legal platform that offers Assisted Entity Conversion as an add-on service. Savvi’s team of experts will help you generate and file your plan of conversion, equity conversion, certificates of conversion, and foreign entity qualification.
Curious about how to convert? Watch this brief video to learn more.