Stay in LLC Structure and Go Public Using an UP-C Structure

Montgomery McCracken Walker & Rhoads LLP - Gary M. Edelson

In the “old days” if your business was in an LLC classified for tax purposes as a partnership and you thought you wanted to take your company public, you were told by the investment bankers to convert your LLC to a corporation. 

Many new businesses were intentionally formed as corporations because the equity owners thought that the exit strategy was to go public. That’s before the UP-C structure came on the scene and the investment bankers got the message that the step up in basis was worth real dollars.

In the UP-C structure, the public shareholders hold the stock in a publicly traded corporation. Its sole asset is an interest in an LLC. The corporation issues stock to the public in exchange for cash. The members of the LLC sell part of their membership interests to the new corporation in exchange for cash. The members of the LLC retain the balance of the membership interests.

This structure permits the business to remain in a pass through environment. The corporation that purchased the LLC interests from the original owners gets a special basis on account of a Section 754 election. The special basis gives rise to amortization and depreciation deductions.

The holders of the LLC interests are given an exchange right, to exchange their membership interests in the LLC for stock in the public corporation or cash. This allows the membership interests in the LLC to track the stock.

Because the publicly traded C corporation has a step up in basis on account of purchasing membership interests in the LLC, its tax liability on a going forward basis is reduced. The corporation and the members who sell membership interests to the corporation enter into a tax receivable agreement pursuant to which the corporation pays to the members who have sold their LLC interests to the corporation money equal to a high percentage of the tax saved by the C corporation on account of the step up in basis. Each time a payment is made, the basis goes higher and higher resulting in more tax savings and more payments under the tax receivable agreement.

The UP-C format for going public structure suggests that startup companies that start out as LLC’s taxed as a partnership remain LLC’s. There is no need to switch to a corporation and lose the step up in basis potential. Remaining an LLC is especially valuable if the startup company does not know whether the liquidity event will be a sale to a strategic buyer, a sale to a private equity group or an initial public offering.

Related post: The “UP-C” Structure (video)

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