Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect. This post is not a substitute for legal advice and is intended to generate discussion of various issues. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Cara Stone, LLP and the author expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion.

Why Do Reorganizations Occur?

Reorganizations have become common across the startup industry. There are many reasons for this, but the primary one is that generally, investors prefer to invest in corporations over LLCs. There are several reasons why this is the case which we have outlined in detail here.  When you look at venture capital numbers across the country the trend becomes increasingly apparent.

For instance, since 2016, 65% of deal volume and 67% of the capital was raised by corporations. In 2019 in Louisiana, 76% of deal volume and 96% of capital being raised by corporations. This data is reflected throughout the country. While there are some instances where forming as an LLC is appropriate, for most companies looking to raise capital, the corporate form is preferred.

This means that many startups who originally formed as an LLC will need to look at reorganizing into a corporation before they raise their initial funding round. Below, we look at some of the factors to consider if you are thinking about a reorganization and how it fits into your fundraising timeline.

What Factors Should Be Considered When Converting from An LLC to A Corporation?

In general, reorganizations should be a relatively straightforward exercise. Reorganizations can take many forms. Two common reorganization structures are for the company to convert from an LLC into a corporation or for the company to merge with a newly formed corporation often created in Delaware. Whatever reorganization structure the company decides on, there are a couple of factors to keep in mind.

  • The company will need to obtain the consent of some level of the LLC members and maybe the board to allow for the reorganization or the merger into the new corporation.
  • The company will need to make sure that it does the reorganization in a tax-free manner or with as little tax impact as possible. The tax implications will vary from company to company so founders should seek experienced counsel to avoid a large tax impact.
  • Some mergers and reorganizations require that you make filings in both the state where the company is currently incorporated and in the new state where the company will be incorporated. If a new state is involved, this may introduce a time element. When the company is dealing with state filings, there can be a delay that is out of the company’s and the attorney’s control. For example, in the Covid 19 pandemic, many state agencies have been weighed down by other matters and companies have seen some delay.

How long do reorganizations typically take?

In general, an LLC to corporate reorganization should not take a significant amount of time and should not be overly costly.

The process generally involves:

  1. Meeting with an attorney to see what structures are already in place that may impact the reorganization.
  2. The attorney will need to draft the particular conversion agreement or agreement on the plan of merger so that the company can affect a tax-free reorganization
  3. The attorney will need to ensure the appropriate filings are prepared for the various states.
  4. The attorney will need to review documents to make sure that both the new corporation and the old corporation have dotted the I’s and crossed the T’s on any new agreements that need to be entered into or any other transfers of agreements or IP that may need to be implemented.

Depending on the complexity of the reorganization, this can take anywhere from 48 hours to a couple of weeks to get done.  In general, this should not be an overly complex or involved process if the company is providing the appropriate documentation.

How much do reorganizations typically cost?

Reorganizations should not be overly costly, and in general, an attorney should be able to provide a reasonable flat fee. However, there are a couple of issues that may add some expense to your reorganization.

  • Because the tax impact of reorganizations can be so large,  tax issues can require some extra research which can add additional expense. (An attorney experienced with reorganizations should be familiar with the issues and should still be able to provide a flat fee or reasonable estimate.)
  • If there is a disagreement within the company on whether the reorganization should take place, this may mean more time needs to be spent in the educational and negotiation stages of the reorganization. Additionally, if additional documents or agreements need to be drafted, this can add additional expense to the reorganization.
  • Finally, if the companies corporate records have not been well maintained or structured, there may be additional expense involved in cleaning up the documentation the company already has.

While these factors can complicate a reorganization and in some cases add additional costs, a typical reorganization should not be cost-prohibitive. An attorney familiar with the reorganization process should be able to give the company a reasonable flat fee to complete the work.

If you have questions or would like to speak to an attorney about your company’s reorganization, get in touch! We’re happy to talk.

 

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