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Many businesses start as S corporations because of their pass-through taxation and relative simplicity. However, as a company grows—adding investors, scaling operations, expanding ownership, or preparing for an exit—the advantages of an S-corp can start to look like constraints.
At some point, business leadership may want to evaluate whether converting an S-corp to a C-corp better supports the company's next stage. Converting to a C-corp is not "better" in every situation, but could be a way to give your business the foundation it needs to grow and thrive. Why might your leadership team consider making this switch?
1. You are seeking outside investment
One of the biggest practical drivers toward C-corp status is fundraising. S-corp limitations can deter investors and prevent the company from receiving funds from some investors entirely. S-corps can't have more than 100 shareholders, shareholders generally must be U.S. individuals (with limited exceptions) and s-corps can only issue one class of stock. This means that most institutional investors, foreign investors and many funds cannot invest, and it can be difficult to structure the preferred equity terms that investors often require.
C-corps, on the other hand, can have unlimited shareholders, multiple classes of stock and can bring in foreign or institutional investors. These features align with common investment terms and venture financing structures, helping you generate more capital for growing your business.
2. You want more flexibility
If you are trying to recruit and retain top talent, equity compensation becomes a serious tool. While S-corps can offer equity, the one-class-of-stock rule and shareholder eligibility restrictions can make scaling equity programs more complicated. C-corps often provide more flexibility to offer stock options, restricted stock and RSUs and options that align employee equity with investor equity.
3. You want to reinvest your profits
S-corps are pass-through entities, meaning profits are generally taxed to shareholders whether or not the company distributes cash. That can create tension when the business wants to retain earnings for growth but owners still owe taxes.
A C-corp can sometimes make more sense when the company's plan is to reinvest earnings rather than distribute them. This is because the corporation pays tax at the corporate level on profits and shareholders generally are not taxed unless dividends are paid or shares are sold. This does not eliminate tax, but it does change the timing of tax payments and change the company's cash flow.
Guidance can help you weigh your options
Because the decision to change our corporation structure can have wide-ranging impacts on your company, it is important to seek legal and tax planning guidance before making that change. Legal and financial professionals can help you weigh your options and manage an S-to-C conversion with confidence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
