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Alternative Methods of LLC-to-Corporation Conversion

When San Diego founders start a business, there are often very good reasons to use a limited liability company (“LLC”) as the startup vehicle. There are some tax advantages, there is the ease of corporate upkeep and maintenance, flexibility with respect to division of profits, and more. However, there are limitations to the LLC form and it is not unusual for the founders, in a later stage of the business, to want to convert the LLC to a corporation. There are several options depending on your business circumstances. A good San Diego corporate attorney can help and offer advice on which option might work best for your business.

San Diego Corporate Law: Statutory Conversion and Other Methods

A common method of converting from an LLC to a corporation is through statutory conversion. See Cal. Corp. Code, § 17710.01 et seq. In California, to use statutory conversion, the LLC files with the California Secretary of State “Articles of Incorporation with Statement of Conversion”. There are various requirements with respect to who must sign the Statement of Conversion; a Plan of Conversion must be adopted, a filing fee paid, final tax returns completed and more. See our discussion here. Once the paperwork is completed, by operation of law, the debts and assets of the LLC automatically become the debts and assets of the new corporation. Here the LLC ceases to exist as a legal entity.

Sometimes, for various business and administrative reasons, alternative conversion options would work better. Assume, for example, that your business just finished printing a pile of vendor form contracts all in the name of Our Business, LLC. Once the conversion is completed, the preprinted forms will not be useful anymore. Or, assume there are several financing documents that defined an “Event of Default” as the conversion of the business into a new corporate form. Or, assume there is a business license in the name of the LLC that cannot be easily or quickly transferred to a new business entity. There may be a number of other good business reasons to keep the LLC entity in place (at least for a short time).

Under these circumstances, one option is to create a parent corporation that will own the LLC. In one sense, this is a corporate restructuring and not really a conversion. But it accomplishes the same result. Here, a new corporation is formed with, presumably, the same owners having the same ownership percentages. Once formed, the owners each transfer/assign their ownership of the LLC to the corporation. Thus, the corporation becomes the single member of the LLC. The business continues — at least for some time — to operate as the “LLC” and over time, contracts, financing and other formalities are shifted over into the name of the corporation. Here, the LLC continues to exist as a legal entity.

A similar alternative is to create a sister corporation and with the eventual aim of selling assets to the new corporation from the LLC or merging the LLC into the corporation at a later point. Again, this is not technically a conversion, but it can have the same practical result. This option is best if there are reasons that the new corporate entity does not want to assume the debts and obligations of the LLC. To avoid fraudulent transfer doctrines, the LLC must either pay off debt or continue as an ongoing business.

With any form of conversion or restructuring, be aware of tax issues. A statutory conversion might, for example, create a taxable event. Likewise, when creating parent or sister corporations, the California Franchise Tax board will treat the new corporations and the preexisting LLC as separate taxpaying entities with separate tax filing and payment obligations.

Contact San Diego Corporate Law Today

For more information on this topic and other aspects of corporate structuring, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a full panoply of legal services for businesses including formation of corporate entities of all types. Mr. Leonard can be reached at (858) 483-9200 or via email. Mr. Leonard proudly serves business owners and residents in San Diego and in the surrounding communities.

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