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Editorial 8 MIN READ

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

Three paths, one clock, and the QSBS window that resets the day you close

The Editors
Staff, Incorporator.org
8 min read Updated
Contents 7 sections
  1. Why the flip happens now, and not later
  2. The three methods, ranked
  3. The tax mechanics, in order
  4. QSBS, which is why founders care
  5. A realistic timeline
  6. Rule of thumb
  7. Sources

onverting an LLC to a Delaware C-corp before a priced round is a four-to-six-week project, not a weekend one. The fastest path is a statutory conversion under 6 Del. C. § 265, which collapses the change of form into a single filing. The tax piece is usually uneventful. The piece that traps founders is timing, and the piece that rewards them is QSBS.

This is the guide for a founder whose lead investor has just said the word "Delaware" in a term sheet and who does not yet have a C-corp.

Why the flip happens now, and not later

Institutional venture money does not buy LLC interests. The reasons are structural: a multi-member LLC taxed as a partnership passes through income to its members, including tax-exempt limited partners of the fund whose UBTI treatment the fund will not tolerate, and foreign LPs whose ECI exposure makes the position worse. Preferred stock with the rights a Series A term sheet describes is easier to draft as Delaware corporate stock than as an LLC class of units. So the term sheet says C-corp, and you comply.

Founders who wait to flip until the week of closing pay for it. The conversion is a board action, a member vote under the operating agreement, a state filing or two, a new EIN (sometimes), a new cap table, new equity docs, and a coordinated tax election. None of that is hard. All of it takes time, and the diligence checklist will ask for the paperwork in final form.

If your lead is serious, start the flip the day you sign the term sheet. If you are raising a priced round in the next two quarters, start now.

The three methods, ranked

Rev. Rul. 84-111, 1984-2 C.B. 88, is the IRS guidance that blesses three forms for converting a partnership-taxed LLC into a corporation. Delaware adds a fourth path of its own. In descending order of how often they are used:

(1) Statutory conversion under 6 Del. C. § 265. You file a Certificate of Conversion from a non-Delaware or Delaware LLC to a Delaware corporation together with a Certificate of Incorporation. The entity's legal existence is continuous; the form changes. The Delaware Division of Corporations fee schedule lists the Certificate of Conversion at a base of $164 plus the $89 certified copy (effectively a set of line items rather than one number), plus the standard certificate-of-incorporation fee that scales with authorized shares. For a 10 million authorized share corporation at $0.0001 par, you are in the low hundreds of dollars in state fees before expedite. One filing, one entity, one EIN that survives if you structure it right. This is what most startup counsel use.

(2) Merger or drop-down. You form a new Delaware C-corp (NewCo), then merge the LLC into NewCo under 8 Del. C. § 264, or you contribute all LLC interests to NewCo and keep the LLC alive below it (drop-down). Functionally similar tax outcome to a statutory conversion when done with care, but with two filings and, usually, a new EIN. Used when there is a reason to keep the LLC as a subsidiary, most often an existing contract that is hard to assign.

(3) Asset transfer. The LLC transfers its assets to a newly formed C-corp in exchange for stock, then liquidates. Paperwork-heavy, consent-heavy, and rare outside of very clean, very small entities. Most counsel will talk you out of it.

Rev. Rul. 84-111 calls these, in partnership-to-corporation terms, the assets-over, assets-up, and interests-over forms. A Delaware statutory conversion is treated as an assets-over transaction by default for federal tax purposes. The IRS has said for decades that the tax consequences differ by form; the differences matter most when members have negative capital accounts or the LLC holds debt in excess of basis. In a clean early-stage cap table where the LLC has raised a SAFE or convertible note but not much else, the consequences usually do not.

The tax mechanics, in order

IRC § 351 is the workhorse. Members of the LLC transfer their interests (or the LLC transfers its assets) to the new corporation in exchange for stock, and if the transferors control at least 80% of the corporation immediately after the transfer (the § 368(c) control test), no gain or loss is recognized. For a founder-controlled LLC flipping into a founder-controlled C-corp, the control test is trivial.

Basis carries over under IRC § 358. Each member's basis in the stock they receive equals their outside basis in the LLC interest they gave up, adjusted for liabilities assumed under § 357. The corporation takes a § 362 carryover basis in the assets, with the usual built-in-loss limitation.

One wrinkle to watch. If the LLC has liabilities in excess of members' aggregate basis in their interests, § 357(c) can trigger gain on an assets-over transfer. It rarely bites an early-stage company. It sometimes bites one that has been running at a loss for two years on convertible debt.

For a multi-member LLC taxed as a partnership, the partnership's tax year ends on the date of conversion under § 708(b)(1). You will file a short-year Form 1065 for the period ending on conversion day, and a short-year Form 1120 for the new corporation from conversion day forward. A single-member LLC is a disregarded entity, so there is no partnership return to close; you file a new Form 1120 and, where needed, a Form 8832 or Form 2553 to confirm classification.

Whether you need an election depends on the path. A Delaware statutory conversion is treated by the IRS as a change of entity form; you generally do not need to file Form 8832 because the new corporation is a corporation per se under Reg. § 301.7701-2(b)(1). If you went the drop-down route and kept the LLC as a single-member subsidiary, the LLC is disregarded by default and no 8832 is needed. You file Form 2553 only if you want S-corp status, which in a venture-backable deal you do not, because S-corp eligibility rules forbid most institutional investors anyway.

QSBS, which is why founders care

Section 1202 exempts from federal tax up to the greater of $10 million or 10x basis of gain on qualified small business stock held more than five years, acquired at original issue from a domestic C-corp whose gross assets did not exceed $50 million at the time of issuance.

The clock starts the day the corporation issues the stock. An LLC interest is not QSBS. Time you held LLC units does not tack. When you convert, the five-year QSBS holding period begins on the conversion date, not the original LLC formation date. Your basis in the new QSBS stock for the 10x-basis alternative is the § 358 carryover basis from the LLC interest, which is usually close to what you put in.

The practical read: if you are flipping before a priced round, you are also starting your QSBS clock before the fund raises the post-money above $50 million in gross assets, which is the point of doing it now. Flip first, raise second. Gross assets for § 1202(d) purposes include cash raised, so the day after a $40 million Series B your window is narrower for any stock issued that day. Stock issued to you before the raise, at the moment of conversion, is issued when gross assets are still below the cap, and that stock carries a clean QSBS status if you hold it five years and the corporation continues to meet the active-business test.

For a founder with a credible exit in year six or seven, the QSBS reset is the single largest tax-planning reason to convert before the round rather than at it.

A realistic timeline

Four to six weeks is typical. A compressed version runs like this.

Week one, you get board and member approvals, order a name reservation if the LLC's name needs to be preserved or cleared, and draft the Certificate of Conversion and the Certificate of Incorporation. Counsel produces a new stockholders agreement, bylaws, indemnification agreements, and an 83(b)-ready stock purchase agreement for each founder's restricted stock in the new corporation.

Weeks two and three, you finalize the cap table in corporate form, converting LLC units to common stock at the agreed ratio, resolving any profits-interest or carried-interest-style grants (which get their own § 83(b) treatment on conversion), and confirming each founder will file a fresh § 83(b) election within 30 days of the conversion date if their shares are subject to vesting.

Week four, you file with the Delaware Division of Corporations. Standard turnaround is a few business days; expedited tiers run from 24-hour down to one-hour for escalating fees. You also update state conformity: if the LLC was registered as a foreign entity in California, New York, or anywhere else, you will file an amendment or a new qualification in the corporate form, and each state has its own fee and timing.

Week five, you notify the IRS (Form 8822-B if the responsible party or address changes, and an EIN continuation letter if needed), the bank, the payroll provider, the 401(k) administrator if any, and every contract counterparty whose agreement does not survive conversion by operation of law. Delaware's statutory conversion statute expressly provides continuity, so most contracts ride through, but diligence counsel will want a clean list.

Week six is buffer. Buffer is load-bearing.

Rule of thumb

Start the flip the day the term sheet is signed, because a statutory conversion takes a month and the QSBS clock only starts once it closes.

Sources

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