Founder's guide
Can an LLC go public?
Why almost every LLC converts to a C corporation before going public, how the conversion works, what happens to an S corporation, and when in the process to do it.
An LLC can register its units with the SEC and a small number of publicly traded LLCs and partnerships exist, mostly in energy and asset management. In practice, a growing business converts to a C corporation before it goes public, because investors expect common stock, the trading system is built around shares, stock option plans need a corporation, and the tax rules take away most of the LLC's pass-through advantage once it is publicly traded anyway. The conversion is routine, takes weeks rather than months, and is one of the first things we do with a new client.
Joel Arberman, Meraki Partners. Based on 17 companies taken public: 11 by direct listing, 4 by reverse merger and 2 by IPO.
Can an LLC be publicly traded?
Yes, in the narrow legal sense. Nothing in the securities laws limits public companies to corporations. An LLC can file a registration statement, its membership units can be quoted and traded, and you can find publicly traded LLCs and limited partnerships on the exchanges today. Almost all of them are in a few specific businesses: pipelines and other energy infrastructure, asset managers, and some real estate and royalty vehicles. They exist because the tax code gives those businesses an exception that most operating companies do not get.
For a software company, a services business, a manufacturer, a restaurant group or any other operating business, the practical answer is that you will convert to a C corporation first. Of the 17 companies we have taken public, every one listed as a corporation, and several started as LLCs.
Why do LLCs convert to a corporation before going public?
Four reasons, and any one of them would be enough.
Investors expect stock
The people in your private placement, the market makers, the transfer agent and every future investor understand common shares, preferred shares and options. Membership units with an operating agreement nobody has read are a conversation you do not want to have fifty times.
The plumbing assumes shares
Transfer agents, DTC eligibility, OTC Markets tiers and exchange listing standards are all written in terms of shares, round lots, public float and shareholders of record. An LLC can be made to fit, at the cost of legal work that buys you nothing.
Options need a corporation
One of the four levers of being public is attracting talent with stock options that have a visible price. Incentive stock options are only available from a corporation, and LLC profits interests are a poor substitute for employees who want something they can understand.
The tax advantage disappears
Under Section 7704 of the tax code, a publicly traded partnership or LLC is taxed as a corporation anyway unless at least 90% of its income is passive or natural-resource income. An operating business fails that test, so it gets corporate tax plus the complexity of issuing a Schedule K-1 to every holder. Converting removes the complexity and changes nothing about the tax.
How do you convert an LLC to a corporation?
Most states, including Delaware, allow a statutory conversion: the LLC files a certificate of conversion and a certificate of incorporation, adopts bylaws, and the members exchange their units for shares in the same proportions. The company keeps its contracts, its bank accounts, its employer identification number in most cases, and its history. Where a statutory conversion is not available, the same result is reached by forming a new corporation and merging the LLC into it, or by contributing the LLC's interests to the corporation.
Done correctly, the conversion is generally tax-free to the members under the rules for contributions to a corporation, though members with negative capital accounts or liabilities in excess of basis can have a taxable event, and state taxes vary. This is a decision for your tax adviser and securities lawyer together, made before the conversion, not after. Most of our clients incorporate in Delaware or Nevada because the corporate law is predictable and investors are used to it, but a company can also convert in its home state.
In cost and time, it is modest: a few thousand dollars of legal work and a few weeks, assuming the members agree. The part that takes longest is usually not the paperwork but settling who owns what, because an LLC's operating agreement often records promises of equity that were never formalized. Cleaning that up before the conversion is far cheaper than discovering it during the SEC review.
Can an S corporation go public?
Not while it is an S corporation. The S election is limited to 100 shareholders, a single class of stock, and shareholders who are individuals, estates or certain trusts. A public company breaks all three almost immediately. The fix is simple: the S election terminates, automatically or by revocation, and the company continues as a C corporation with the same legal entity, the same charter and the same shares. There is no conversion to file. The tax consequences of leaving S status, including the built-in gains rules on later asset sales, are worth a conversation with your accountant, but they rarely change the decision.
What about a sole proprietorship or a partnership?
A sole proprietorship has no entity to take public, so the business is contributed to a new corporation. A general or limited partnership is in the same position as an LLC: it can be converted or merged into a corporation, and the partners become shareholders. In every case the operating business, its contracts and its people carry over; what changes is the wrapper.
When should you convert?
Before the private placement, which means near the very start of the process. Investors in the raise should be buying shares of the corporation that will go public, at the price that will become the reference point for the first trade. Converting after the raise means re-papering every investor, and converting during the SEC review means explaining the change in the registration statement. In our sequence, the conversion happens in the first weeks, alongside cleaning up the cap table and planning the board. See how to take your company public for where it falls in the ten months.
Does converting change what the company is worth?
No. Valuation comes from the business, the plan and the price your investors pay in the private placement, not from the entity type. What the conversion does change is what you can do with the equity afterward: issue options, sell shares to the public, use stock in an acquisition. Those are the levers that build value over the years after listing. See how a company is valued when it goes public.
Is there any case for staying an LLC?
Only if your business is one of the few that passes the 90% qualifying income test and you have a specific reason to want partnership tax treatment for public holders. That describes pipelines and certain investment vehicles. It does not describe the companies that come to us, and we have never recommended it. For everyone else, the LLC was the right structure for a private business, and the corporation is the right structure for a public one.
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