When you are starting a business, you select what appears to be the best structure for your company, whether this is a corporation or an LLC.
However, once the business is up and running, what was once a shrewd decision, no longer seems the best course of action. This can be particularly true if the business is growing rapidly and needs significant infusions of capital or there are new tax planning strategies that can benefit the business and its owners. In these cases, the owners may want to change from one business type to another. For example, the owners may wish to change from a corporation to an LLC.
This process of changing formal entity types is known as a “conversion.” A conversion is a statutory transaction in which one type of business entity becomes a different type of business entity—such as an LLC becoming a Limited Partnership.
In a conversion, all assets, property, debts, and liabilities of the converting entity vest in the converted entity. The converted entity is for all purposes the same entity as existed before the conversion, just in a different form.
All state LLC Acts have provisions that permit an LLC to convert to another business entity and authorize another business entity (such as a corporation) to convert to a limited liability company. However, the rules vary widely from state to state, so it is important to work with an experienced business professional to make sure that all the statutory nuances are covered.
CT tip: Although a conversion involves only one entity, it involves two state statutes—the one governing the company’s existing business structure (e.g., an LLC), and the other governing the entity into which it will convert (e.g., a corporation). It is important to check both statutes—to make sure they each authorize the proposed conversion and to find out what steps have to be taken to complete the transaction.
Steps required for conversion
In general, an LLC may convert to another business entity by approving a plan of conversion that contains the terms and conditions of the conversion and the manner and basis of converting the membership interests into interests of the converted entity. The members must approve the plan. The vote required for approval (unanimous, two-thirds) should be set forth in the LLC’s operating agreement. If it is not, then the default provisions of the formation state statute govern.
CT tip: Converting from one entity type to another can have significant tax ramifications. Before proceeding with a plan of conversion, it is wise to work with a tax professional who can map out the short- and long-term consequences and help structure the transaction to maximize the savings and minimize the risks.
Once the plan has been approved, then the converting LLC must file articles of conversion. If the LLC is converting to another statutory entity, such as a limited partnership or a corporation, it will have to file the appropriate formation documents for that type of business. If the company has registered to do business outside of its formation state, then it will be necessary to file documents with each of those states indicating that a conversion has occurred.
A similar process will apply if a corporation or other formal statutory entity wants to convert to an LLC. The owners of the converting company must approve the plan of conversion; the converting entity must file articles of conversion and then file the appropriate formation documents for the new entity. And, similar procedures for each state where it is registered to do business.