Forming an LLC is an important first step of any business venture. The sooner you choose a legal entity for your business, the sooner you protect yourself from personal liability. If you feel that your business has outgrown its legal structure, you may wonder if you can convert a Delaware LLC into a Series LLC.
Depending on the type of business, you may benefit from separating business assets using a Delaware Series LLC. Here’s how to convert an LLC to a Series LLC, plus some important points to consider.
How To Convert an LLC Into a Delaware Series LLC: Three Steps
Follow these steps to convert an existing LLC into a Series LLC in Delaware:
Step 1) Amend the Formation Document.
The first step to convert an LLC into a Series LLC is to file an amended version of the LLC’s Certificate of Formation.
Owners need to add a new article to the Certificate that includes specific language providing statutory notice of the company’s ability to create protected series.
A Series LLC’s Certificate of Formation should cite Delaware Code Chapter 18, Section 215. This section details the internal liability shields provided to protected series.
Note that this filing is technically an “Amendment” and not a “Conversion”.
Step 2.) Amend the Operating Agreement
Owners must also amend the LLC’s Operating Agreement to reflect the new entity structure.
The Operating Agreement is the private contract between an LLC’s members that governs the company’s internal affairs. An LLC Operating Agreement details each member’s ownership interest, their management responsibilities and procedures for adopting changes.
Members create the initial protected series by naming them in the new Series LLC Operating Agreement. The Series LLC Operating Agreement should also provide a framework for creating or terminating protected series in the future.
Tip: It is important that members include an exhibit in the Series LLC Operating Agreement listing each protected series.
Each protected series should also have its own, mini-Operating Agreement. These are called “Separate Series Agreements”. Separate Series Agreements specify which members are associated with a particular protected series as well as their percentage ownership in the series. Series Agreements also designate the series managers and list any special or limited purpose of the protected series.
Step 3.) Maintain Separate Records for Protected Series
Maintaining separate records for each protected series is not just recommended, it is required by law. Delaware’s LLC Act includes stern record-keeping requirements for Series LLCs.
Managers must meet these requirements to preserve the internal liability shields between protected series and the parent Series LLC.
Avoiding the commingling of assets across protected series is crucial to operating a Series LLC. Series LLC owners can leave assets vulnerable to creditors of other related businesses if they fail to properly associate the assets with a particular protected series.
Each protected series should have a separate asset ledger, financial records and contracts. The asset ledger should provide details that allow someone to easily trace the asset ownership. This may include the date the asset was acquired, the quantity and the date disposed of.
Experts recommend not to combine the finances of a protected series in a joint account, like a law firm escrow account with a cash management agreement. The best practice is to establish separate bank accounts for each protected series. Separate bank accounts can be easier to manage and can provide better protection for business assets.
What Is a Delaware Series LLC?
The Delaware Series LLC is an innovative type of legal entity that allows you to protect the assets of multiple businesses. A Delaware Series LLC is able to create separate asset chambers called “protected series”. Each protected series has its own limited liability shield that can protect its assets from the creditors of other related businesses, or the general LLC.
The Delaware Series LLC uses an asset protection strategy called “ring fencing”. Think of ring fencing like horses in a barn. With a Series LLC, entrepreneurs can manage multiple businesses under one roof, however, their individual assets and liabilities are fenced off from one another in separate stables.
What Are the Series LLC Business Benefits?
Serial entrepreneurs can benefit from reduced startup costs and better administrative efficiency by using a Series LLC.
The Delaware Secretary of State requires only one Certificate of Formation to be filed to create a Series LLC. A Series LLC can then create an unlimited number of protected series through its private Operating Agreement without making any additional filings. A Delaware Series LLC is also only required to make one Annual Franchise Tax payment no matter how many protected series it establishes.
The benefits of a Series LLC are clear when compared to the traditional method of forming multiple LLCs which requires paying filing fees and owing Annual Franchise Tax for each entity.
How Does a Delaware Series LLC Provide Protection?
Delaware law considers each protected series to be a separate legal person. Protected series are allowed to enter into contracts and be sued in their own name without involving general LLC.
Should You Convert an LLC To a Series LLC?
Many business owners may find the process of converting a Delaware LLC to a Series LLC to be daunting. Converting to a Series LLC involves properly distributing business assets of the original LLC across the newly established protected series.
Business owners can be prone to making mistakes during this process. For example, if it requires changing title in real property to reflect updated ownership. Converting an LLC can be made even more challenging if the company has extensive contractual obligations or outstanding debt.
Another option is to form a new entity as a Series LLC, then carry out an asset transfer from the existing LLC to the protected series.
Delaware Series LLC vs. Holding Company
A single LLC can be used to manage multiple portfolio businesses under one entity. This practice is known as forming an “Umbrella LLC”. Many entrepreneurs use Umbrella LLCs, however, this strategy can come with significant liability risk.
Operating a single LLC for multiple businesses is like having all your eggs in one basket. It may be administratively convenient, however, if one business experiences issues, every single egg could crack. Many entrepreneurs achieve liability protection by forming multiple LLCs that are all owned by a single company. This is referred to as forming a holding company.
A holding company often does not own any assets directly. Instead, the company owns membership interests in individual operating businesses. This structure allows entrepreneurs to consolidate the ownership and management of multiple businesses while keeping their assets and liabilities separate.
Forming separate LLCs for individual assets can provide better liability protection; however, this is not economically practically for every business. The Series LLC can provide the legal benefits of a holding company structure with only one filed entity, lowering startup and administrative costs.