Let's you'd like to convert an existing Delaware LLC to a Delaware C-Corp that already generates some revenue.
Is it necessary to do a fair-market valuation before assigning a nominal value for the new C-Corp shares or can the value of those new shares be arbitrary and very low (as is the case for new startups)?
The question is relevant in the case where the new C-Corp would like to give some incentive to pre-seed employees. If the value of the company is already significant (i.e. not close to 0), stock options might not be an effective tool, as the strike price would be too high and have an adverse tax effect on early employees (if they'd like to make the 83-B election, for instance). I would imagine that RSUs would be the way to go in that case and that a stock options pool would be created right after the first seed investment (if any). Of course, those thoughts are moot if it is possible to assign an arbitrary value to the new C-Corp stock. Note that it's not a new C-Corp that acquires the old LLC, but a continuing C-Corp (through a conversion).
Thanks in advance for any feedback from those who've already gone through that process.
Thanks all for your responses. I guess I wasn't really clear about my objectives here, but the concern really isn't for the existing LLC members (and future Corp shareholders), as I indeed believe the conversion to C Corp is a transparent event with no tax consequences.
The issue I have is that one of the members bought his membership interests 2 years ago at an original valuation of $50K. The company is probably worth 10x that now, and though that's still insignificant in itself, it probably isn't if I want to hire and incentivize early non-founder employees.
I would consider stock options if the company was worth, say, $1,000 because the stock options would be appealing to early employees even if the company grows organically without outside funding. If the company valuation is closer to what it really is and the company only grows at, say, 2x per year, then stock options might look pricey for an early employee. Hence the idea of compensating these employees with free stock, i.e. RSUs.
However, my concern is that I have to explain why we're granting RSUs and not stock options, because RSUs are mostly used at large, established companies while stock options are still heavily used at venture-founded startups.
Since my company is neither large (of course) nor venture-founded, I'm wondering which incentive tool looks best (regardless of other factors) for early employees as I'm converting the LLC to a C-Corp (since giving stock incentives in an LLC is rather complex as not well understood, as far as I know).
Assigning an artificially low value to the new C corp would make stock options viable (and hopefully avoid lengthy discussions with potential hires), but I wonder whether that's legally acceptable or not (for existing members, that artificially low value doesn't matter much since they're only concerned with a liquidity event, not a mere valuation - that's not a general statement, just the specific situation with my company).