This week’s podcast episode with Tony Summerville was all about the why of converting an LLC to a Corporation. Tony gives us a behind-the-scenes look of his process of making the decision of conversion. As an exclusive for you, I wanted to make our conversation this week about the how of that conversion.
I would encourage you to listen to the episode for some thoughts on why you might make this conversion. If you have any additional questions on the how or the why, you can just hit reply or leave me a voicemail. Tony, in the episode also gave out his email address if you are interested in discussing the issues with someone in the trenches instead of me.
If you have decided you need a Corporation instead of an LLC, how do you make that happen?
Used to, it was a much more complicated transaction. To truly understand what is going on, let’s discuss what actually happens with the business and how you go from an LLC to a Corporation. Then, I will show you how the process has been simplified.
What Happens on Conversion
When any entity is converted to another entity, you would have to merge two companies together. That means, to change an LLC to a Corporation you would have to:
- Have an LLC to begin
- Form a new Corporation
- Merge the LLC into the new Corporation
This, of course, created a number of issues that you needed to make sure you dealt with. First of all, you were basically starting over. The Corporation had to be the entity that was still standing after the merger with the original LLC. That meant your company that had been around for longer than the new Corporation it became would go away. This created issues with leases, contracts, vendors, merchant companies, your FEIN (and everything associated with it). Basically, this transaction, though not technically complicated because it all happened on paper, created a number of issues in the day-to-day operations of a company.
It also used to create some potential issues in the naming of companies as companies could not be named the same as other companies. So, even though you could transfer the trademarks, you would need a different name for the corporation you formed before the merger.
It was complicated. But, it isn’t as complicated any more.
This is still basically what happens. Most states have made it much simpler. Conversion is such a common occurrence, it made sense to make it a simple transaction. In some states, it is a simple form that is filed with the Secretary of State. In our conversation today, we will dive into the specifics of an Alabama conversion.
How to Handle a Conversion
Obviously states have different ways of handling this, but the process is relatively standard. In Alabama, you need to:
- Have unanimous approval of the Members – This can be adjusted if your Operating Agreement covers the issue of conversion before you are making a decision (for instance giving the managers the authority to make the conversion).
- Form a new Corporation that indicates it is created by conversion of the original LLC by filing Articles of Incorporation (with a few additions as I note below)
Oddly enough, Alabama does not have a model form available on the Secretary of State’s website to help. You can find a model Certificate of Formation (their new name for all formation documents) for a corporation. I will give you the additional requirements you need. I will say, I do not love the templates offered by the Secretary of State. They are confusing. This is part of what I am working on in the Resource Center. But for now, we can discuss the additional requirements of the Articles of Incorporation for the new Corporation that is converted from your LLC. You need to include the following in addition to the normal items required in Articles of Incorporation.
- A statement that the new corporation was converted from another entity
- The name of your original LLC
- The probate court where you filed the original articles of organization for your LLC (this should be in the county where your original registered office was located)
- A statement that the conversion was approved as required by law or the Operating Agreement of the original LLC
Once you have filed the new Articles of Incorporation (they have started calling it a Certificate of Formation for all entities now), you also need to file a Certificate of Termination (formerly Articles of Dissolution) for your original LLC. The Certificate of Termination, which can also be found on the Secretary of State’s website (though without the additional information), must include the following additional information:
- A statement that the original LLC was converted to a corporation
- The name of the new corporation
- The probate court where you filed the Articles of Incorporation for the new corporation
The conversion will take effect when the last document is received by the probate court. The statutes are clear that a certificate of termination for your LLC is not effective until the certificate of formation has become effective. That just means you can’t accidentally terminate your LLC before you have created the new Corporation for the conversion. This protects you.
What If You Want this to Happen on a Certain Date
Sometimes, you want a certain date to be the effective date. This is often for accounting reasons (the end of a quarter or the end of a fiscal year). The probate courts and Secretary of State cannot always be relied on to file your documents immediately when you mail them in (the secretary of state is typically behind by 3-6 months depending on the time of year). To make sure your documents are effective when you want them to be you need to include the date and time of conversion on both documents you are required to file. This is in addition to everything else I mentioned above. You also need to file the documents before that date. You need to make sure they are filed before the date you want them to be effective. That means if the probate court is behind in filing (like in Jefferson County), you need to file everything early to make sure it can be effective on the date you choose. Close of business is presumed if you do not specify a time.
Other states, Delaware specifically, has a simple form you file. It is much simpler, but this is the process in Alabama. It is, like I said, simpler than the way we used to do it.
Doing it this way makes everything stay the same. It keeps the liabilities, assets, and everything else in the business the same. The entity is not considered to have changed, but to have converted. This is, legally, a very different thing. You have not created a new entity that now owns the assets of your old one, you have converted the old entity to a new form.
That means, any liabilities you had before are still liabilities now. Any potential claims anyone had against you before are still available. Any liens against your property are still there. There was no sale of assets. There was no transfer of property. The entity changed to something new, but everything else is the same. It is almost the same, legally, as getting married. Nothing has changed except the status.
The benefits of a conversion are certainly clear. With any kind of complicated investment structure, or desire to give equity in different ways, it may be more beneficial to have a C-Corporation. In some instances, however, the complexities already exist and everyone is used to dealing with them because they were that way from the beginning. It is possible to contractually make an LLC look almost identical to a C-Corp, but sometimes it doesn’t make as much sense. Like Tony mentioned, the real deciding factor is the why.
There are, of course, tax consequences to the conversion itself to consider, but that is for another time.
I will talk to you next week, unless you talk to me first;)
P.S. I am working on some resources like this, but in more detail. If I were to expand this content and make it more thorough (with templates, videos, or screenshots) would you be interested? Would you be interested in that type of explanation series for other types of documents? What documents?
Would you be willing to pay for the courses? Would you prefer to see the courses bundled?
I am trying to bring information to help you understand the legal that affects your business everyday in an easy to understand and affordable way. How would you like best to learn about this (or other) types of transactions? Hit reply and let me know!