Should You Convert Your Startup from a California LLC to a Delaware Corporation?

AdobeStock_558703638-300x169When it comes to forming a new startup, a California limited liability company (LLC) offers a number of advantages. As the name suggests, an LLC protects the personal assets of individual members from business creditors. And since the LLC is a “pass through” entity, any profits are taxed on the returns of individual members.

But while this arrangement may be ideal for founder-run startups with just a few equity holders, once the business seeks financing from venture capital or other investors, it is often necessary to convert to a corporation. More precisely, a California LLC may need to convert to a Delaware Corporation. The California corporations attorneys at Structure Law Group can advise you on the benefits and drawbacks of making this move. Contact us today to schedule an initial consultation.

When Is a Conversion Necessary?

From the standpoint of capital, investing in a corporation is usually preferred to investing in a limited liability company. There are a couple of reasons for this. First, the corporation pays income tax as an entity rather than passing it through to individual shareholders. Shareholders are only taxed when they either sell their stock or receive dividends from the corporation. Investors are therefore generally far more comfortable dealing with an established C corporation.

Second, it is also far easier for a startup to issue equity to investors, as well as key employees, if the business is structured as a traditional C corporation rather than an LLC. This is critical, as investors obviously want to scale up the business quickly. On the other hand, if a startup is looking to remain relatively small, or is simply not ready for rapid growth, then conversion may not be advisable at the present time. Keep in mind there is a significant expense involved with converting a California LLC into a Delaware corporation in terms of both tax and regulatory compliance. So it is important not to rush into a conversion decision without speaking to an experienced attorney.

Why Form a Delaware Corporation?

Roughly half of the publicly traded corporations in the United States are legally incorporated in Delaware. This is the state long preferred by venture capital firms, investment banks, and other startup investors for a multitude of reasons. Delaware has a dedicated Court of Chancery whose judges are specialists in corporate law. This means cases tend to be decided more quickly and in a more predictable manner. Delaware also imposes no income tax on corporations that only do business outside of the state. There is, however, an annual franchise tax.

Speak with a California Corporations Lawyer Today

There are a number of legal formalities that must be observed when converting a California startup from an LLC to a Delaware corporation. It is critical not to overlook any of the necessary steps as that can lead to unexpected regulatory and tax problems down the road. So if you need to speak with an experienced California corporations attorney about your startup’s needs, contact SLG today to schedule an initial consultation.