Discussing how to change your business structure

4 Reasons to Change Business Structure

As your small business expands and evolves, it may make sense to consider changing its structure. Many small businesses start out as sole proprietorships or partnerships, with only one or two owners and no employees. Over time, as your business grows and changes, a more complex business structure may become beneficial. There are several key considerations when deciding whether or not to change your business structure. This move might not be right for your company, so remember to take the following aspects into account:

#1 Protection from personal liability. If your small business has hired employees, taken out loans, or provided products or services to customers, you, as the owner of the business, may be exposed to extensive personal liability for business-related damages in lawsuits against the business unless you have selected a business entity that limits potential liability to business assets. In an LLC, for example, members can only lose the amount they invested. They generally aren’t liable for business debts or obligations. 

#2 Changes in ownership. If you are a sole proprietor but want to add one or more business partners, it is beneficial to formalize the arrangement by entering into a partnership or limited liability company (LLC). The partnership or operating agreement should clearly spell out everyone’s rights and obligations.

#3 Obtaining financing through a bank or funding from investors. Banks often prefer to give loans to businesses that have opted for a more complex business structure, seeing them as less risky. If you are planning to seek a loan, it may be advantageous to adopt a more formal structure. Investors also often prefer business structures that minimize their risk. For example, in a limited partnership, limited partners have invested money but have a minimal role in day-to-day operations. This means they are not liable for business debts or obligations.

#4 Different tax treatment. Some business structures, such as sole proprietorships, partnerships, certain LLCs, and S corporations are pass-through entities, which may be eligible for the 199A deduction under the new tax law. However, the corporate tax rate went down to 21 percent under the new law. These factors, as well as whether you must pay self-employment taxes, should be considered in determining the most advantageous structure for your particular business. 

How to Make the Change 

The appropriate way to change to another type of business structure depends on how you currently organize your business. It also depends on the type of business you want to form. The following are a few examples of typical scenarios.

When sole proprietorships or partnerships aren’t separate legal business entities, business assets and liabilities aren’t considered separate from the owners’ personal assets and liabilities. This means that changing to an LLC or corporation simply entails filing the required paperwork with the Secretary of State. LLCs usually must file articles of incorporation and pay a filing fee.

NOTE: In all but five states—New York, California, Delaware, Missouri, and Maine—having an operating agreement is not required. However, creating one is considered a best practice and lets you customize how your LLC functions.

Corporate statutes typically impose additional requirements, for example, preparing corporate bylaws, appointing directors, and issuing stock. If your business is a C corporation, you may be able to have it treated as an S corporation. This happens by filing a timely IRS Form 2553 with the Internal Revenue Service. It also avoids the “double taxation” that exists for C corporations, since S corporations are “pass-through” business entities. The S corporation itself is not subject to federal income tax; rather, company shareholders pay income tax on their share of the S corporation’s profits. This option is only available for corporations with only one class of stock and 100 or fewer shareholders. These shareholders must be individuals, not LLCs or partnerships. They must also be legal residents of the United States.

If you are converting an LLC into a corporation or vice versa, you can dissolve the original business entity and form a new one. However, this can be a time-consuming and expensive process. Many states now have statutes establishing a simplified conversion process. This eliminates the need to start the business over from square one. Instead, the conversion can take place by filing the required forms with the office of the Secretary of State.

Note: For any type of change, it is important to make sure that you complete all of the notifications and registrations required by state law. For example, you may need to request a new Employer ID Number (EIN), file a new fictitious name statement, and notify the state tax agency of the change.

Give Us a Call 

There are many factors to consider when deciding whether to change the structure of your small business. As business law attorneys, we can help think through and implement the most advantageous business structure for your individual circumstances. Please contact us today to set up a consultation.

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