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Editorial 6 MIN READ

Converting an LLC to a C-corp before the priced round

Three mechanical paths, the tax rule that actually matters, and the QSBS clock you are really buying

The Editors
Staff, Incorporator.org
6 min read Updated
Contents 6 sections
  1. The three paths, ranked by how often they are right
  2. The tax rule you have to land on
  3. The QSBS clock, which is why you are really doing this
  4. The timeline, the BOI wrinkle, and the landmines
  5. Rule of thumb
  6. Sources

he lead investor's term sheet says Delaware C-corp, and your company is a Delaware LLC. You have four to six weeks before closing and three mechanical paths to choose among.

This is a guide to converting an LLC to a C-corp before a priced round. It assumes you are flipping because the term sheet demands it, and that you care about Section 1202 QSBS.

The three paths, ranked by how often they are right

The first path, the one most venture counsel reach for, is a statutory conversion under 6 Del. C. § 265. You file a Certificate of Conversion and a Certificate of Incorporation with the Delaware Division of Corporations in a single step. The LLC ceases to exist as an LLC the instant the conversion is effective; the same legal entity continues as a corporation, with the same EIN, contracts, bank accounts, and lawsuit history. No assignment of assets is required, because no assets move.

The second path is a merger or drop-down under 8 Del. C. § 264, which authorizes a merger of a Delaware LLC with or into a Delaware corporation. You form a new Delaware C-corp (NewCo), then merge the LLC into NewCo with NewCo surviving, exchanging membership interests for NewCo stock. Two filings instead of one, and a paper trail some diligence teams prefer. Go-to when the cap table has exotic terms or lenders have covenants a conversion might tickle.

The third path, asset transfer, is when the LLC sells its assets to a newly formed C-corp for stock, then liquidates. Rarely right: you trigger consent on every assignable contract, re-paper the IP, risk transfer taxes on real property, and send customers novation letters. Use it only when the LLC has liabilities or minority members you cannot bring along.

For a typical Delaware LLC with clean membership interests, § 265 is the default. The merger path is the default when the cap table is ornate or investor counsel drafts that way.

The tax rule you have to land on

A multi-member LLC converting to a C-corp is, for federal tax purposes, a transfer of property to a corporation for stock. It qualifies for non-recognition under IRC § 351 if immediately after the exchange the transferors are in control, meaning at least 80% of total combined voting power and 80% of each class of non-voting stock. IRC § 721 also plays on the partnership side. You meet control naturally in a flip because LLC members receive the stock; you fail it if a new investor is wired into the same transaction such that members drop below 80% at the moment of exchange. Time closings so the round closes after the conversion, not concurrently.

Rev. Rul. 84-111, 1984-2 C.B. 88, lays out three forms:

  • Assets-over: the partnership transfers assets to the corporation for stock, then distributes stock to partners in liquidation. This is what a § 265 statutory conversion is generally treated as producing.
  • Assets-up: the partnership distributes assets to partners in liquidation; partners contribute them to the corporation for stock.
  • Interests-over: partners transfer interests to the corporation for stock, and the partnership is treated as liquidated. This is what a § 264 merger most naturally resembles.

Economic result the same; basis and holding-period mechanics differ. Tell your CPA which form you executed.

Basis in the new stock is governed by IRC § 358: stockholders take a basis equal to their basis in the property transferred, adjusted for gain recognized and boot. In a clean flip with no boot, each member's basis in the LLC interest carries over. The corporation takes a transferred basis in the assets under § 362.

The QSBS clock, which is why you are really doing this

The reason sophisticated founders push to flip before the priced round is IRC § 1202. Stock issued by a domestic C-corp with aggregate gross assets of $50 million or less at issuance can, if held five years and other requirements are met, be sold with up to the greater of $10 million or 10 times the taxpayer's basis in that stock excluded from gain, per-issuer, per-taxpayer. That is the single largest federal tax benefit available to founders of venture-scale companies.

The clock starts when the corporation issues the stock, not when the LLC was formed. A conversion or merger that produces newly issued corporate stock is a fresh issuance for § 1202; your five-year hold runs from the effective date. Flipping six months before the round gets you six months of QSBS clock you would not have if you flipped after.

The $50 million test is measured at the time of issuance (and immediately after), another reason to flip first. If you convert the morning a $50 million Series A wires in, you risk breaching the cap at issuance. Convert first, then raise: the founders' stock is clearly QSBS; investor stock is analyzed on its own facts.

Three corporate-level requirements catch founders: C-corp status for substantially all of the holding period; at least 80% of assets used in an active qualified trade or business; and excluded industries under § 1202(e)(3) (professional services, finance, farming, hospitality). Software, hardware, most consumer and enterprise tech: qualified. Law firms, dental practices, restaurant groups: not.

The timeline, the BOI wrinkle, and the landmines

Four to six weeks is the honest window. Critical path: board and member consents under the operating agreement (these usually slip); drafting the Certificate of Conversion and Certificate of Incorporation (6 Del. C. § 265; 8 Del. C. § 102, with same-day or two-hour expedite available); new bylaws, stockholders' agreement, and equity plan; federal tax classification (Form 8832 is generally not required because the entity becomes a corporation by operation of state law; Form 2553 is a separate S-election question that almost never applies in a venture flip); and any novations for items the statute does not carry over.

Under 31 CFR 1010.380, a reporting company files an updated beneficial ownership report within 30 days of any change in beneficial ownership or company information. A conversion changes the entity type, usually the officers, and often beneficial ownership. File the update. The Supreme Court on January 23, 2025 stayed one of the injunctions against CTA enforcement (McHenry v. Texas Top Cop Shop, No. 24A653), and FinCEN's enforcement posture has moved several times. The statute itself remains in force. Filing on time is cheap; back-filing if enforcement tightens is not.

Two cap-table landmines. Profits interests under Rev. Proc. 93-27 and Rev. Proc. 2001-43 carry over as restricted stock or options; the corporate analog of a profits interest does not exist. The 83(b) election window on new restricted stock is 30 days from the grant, which in a flip is 30 days from the conversion effective date. Missing it is a tax disaster. Convertible notes and SAFEs issued by the LLC survive the flip at their terms; most post-2018 Y Combinator post-money SAFEs are drafted for a corporate issuer and convert at the priced round, not the entity flip. Pre-2018 SAFEs and non-standard notes need a lawyer's eye before you file.

Rule of thumb

Flip via 6 Del. C. § 265 statutory conversion, time the effective date to precede the priced round by at least a day, get the 83(b) elections filed within 30 days, and file the BOI update on day 29.

Sources

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