Converting Your Startup to a Delaware Corporation, Correctly.
TL;DR Nutshell: If you’ve accepted that you need to convert your startup to a DE corp from a different entity type, then it’s also time to accept this: there is no off-the-shelf, “click a button and file” way to convert to a DE corp. It is highly contextual. The right lawyers can do it efficiently and correctly. The wrong ones will tell you it’s simple, screw it up, and require you to pay the right lawyers 5x more in the future to clean it all up.
- Should I incorporate in my home state or Delaware?
- Why incorporating in Delaware is always cheaper (long-term)
- Why you’ll (generally) need to be a C-Corp to raise venture capital
The purpose of this post is not to debate whether your startup should be a Delaware corporation. While we do work with a decent number of VC-ish backed Delaware LLCs (sometimes LLCs really do make sense), the vast majority of technology companies that raise venture capital either start or end up as Delaware corps. And the moment a lawyer starts playing contrarian with me, talking up why Delaware isn’t needed, or C-Corps are tax inefficient, I quickly end the exchange by asking how many VC-backed companies she’s actually worked with. We are talking about scaling tech companies and venture capital. Not small businesses or companies funded by local, non-institutional investors.
So for purposes of this post, we are going to take it as a given: you need to be a Delaware corporation, but you aren’t one right now. Converting is simple, right? Just file a form?
Converting from any kind of entity to a DE Corp is not “standard.” Ever.
Properly forming a DE corp startup from scratch has, thanks to standardization and automation, become a relatively straightforward process. The reason, of course, is that you’re starting from nothing, and nothing is the easiest condition to automate from; no messy context throwing a wrench in the system. Conversion, however, involves a history with any number of possible permutations, and that means all the shiny templates and technology must give way, partially, to human judgment.
- What are your state’s rules around entity “conversions”; is a “statutory conversion” allowed, or will you need to do a merger or possibly even an asset sale? It depends.
- What approvals does your state’s rules require? It may be a majority of all equity, it may be 2/3, it may be unanimous. It depends.
- What specific documentation (like a “Plan of Conversion”) and filings (often in both states, not just DE) do the rules require? It depends.
- Are there any existing agreements in place that might require a separate consent to be obtained before the entity can convert? Ok you get the idea.
- Does the company’s existing capital structure require a (hopefully quick) discussion with tax counsel regarding possible tax hits (phantom income) resulting from the conversion? This is a crucial issue to consider when converting an LLC to a Corp.
Converting a Non-DE Corp to a DE Corp (Corp to Corp) is generally simpler than converting an LLC to a Corp. Converting any entity in a state that allows for statutory conversions (TX and CA do, NY does not) is generally simpler than having to do a statutory merger. Whatever the context, you will screw it up trying to do it yourself. In fact, I’ve lost count of how many law firms have screwed it up, requiring founders to pay us 5–10x in cleanup costs than they would’ve paid if they had just hired competent counsel from Day 1.
The reason you will never just push a button to receive medical treatment is that every person is different, and tailoring high-stakes treatment to individual differences is precisely what professional judgment (supported by tech, of course) handles best. Startup law is no different. Technology and tools absolutely cut down on waste, and yes there is a lot that is standardized even in conversions. But in the end the institutional knowledge of the law firm you choose will determine whether it gets done efficiently and correctly, or whether you’re just deluding yourself into thinking that the guy promising a cheap, simple conversion actually knows what he’s doing.
Originally published at Silicon Hills Lawyer.