Why Convert a Corporation Into an LLC?

By David Heymann

One of the primary reasons that people decide to convert a corporation into a Limited Liability Company or LLC is to add flexibility in management and ownership.

Consider the following common scenario: Walter owns 50% of a corporation and Mindy owns the remaining 50%. Both, however, agree that Walter should get a greater percentage of profits after certain events occur, say 60%, with Mindy receiving the remaining 40%.  Also add to that the fact that Mindy will control most of the decisions of the entity.

With a corporation, this simple change cannot be accomplished without creating multiple agreements, issuing additional shares to Walter upon certain events or possibly creating different classes of stock.  It is further restricted if the corporation is an S Corporation because of the restriction in the Internal Revenue Code on S Corporations having different classes of stock. However, with an LLC, distributions and control are not married to amounts invested where a nominal “owner” or even a non-owner, known as a manager, can control management and receive a disproportionate share of profits.  

If you have an existing corporation and desire to “convert” it to an LLC, some states, such as Delaware, allow direct conversion by simply filing of a certificate of conversion directing the change from a corporation to an LLC.  In other states, such as New York, a direct conversion is not permitted but can effectively be achieved by merging your existing corporation into a newly-formed LLC.  It should be noted that the conversion of a corporation to an LLC will have tax implications and prior to converting one should discuss with their tax counsel.  A conversion may require the consent of lenders or other third parties with whom the corporation has entered into a contractual relationship.

LLC’s are particularly beneficial in family businesses and businesses where there is a “worker” partner and a “money” partner.  Assume you are a real estate owner and wish to vest any future appreciation in your children while holding something back for yourself; an LLC lets you stipulate that after you get x dollars and a certain return, the balance or a substantial portion of the balance can go to your kids.  Similarly, if you are the worker partner you can structure an LLC such that after the money partner gets its capital back plus a return, you receive a “promote” or “carry” interest which is disproportionate to the capital you contributed.  In a corporation, these “shifting” percentages are not so easily accomplished.

The management flexibility provided by an LLC is another plus.  For example, in a corporation its shareholders elect directors, and these directors elect officers.  You may have a shareholder’s agreement that says “we’re all going to vote a certain way” but you cannot necessarily bind directors to vote for certain officers.  In an LLC, however, the operating agreement can vest as much or as little control in each member or, as noted above, a non-member.  So in the examples above, the parent or “worker” member could have total control, shared control or no control. In an LLC it is all a negotiation among the owners.

There are many rules about running a corporation.  With an LLC, however, you can contractually agree to do almost anything you want.  The LLC gives you the ability in a streamlined manner to structure management and tailor the entity to do what the client needs in order to accomplish its goals, whereas to achieve the same outcome in a corporation would be, if even possible, more difficult and costly, as well as more burdensome from an administrative standpoint.  

Before making any decision about converting your corporation into an LLC, or any changes that affect your business or your estate, be sure to seek counsel from a qualified team of advisors who can help you determine your best options and processes.

 

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This blog posting is for informational and educational purposes only. It is general in nature and not person or circumstance specific. This blog posting is not intended nor should it be construed as rendering independent investment, legal or tax advice. It may but does not necessarily constitute attorney advertising.
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