Small businesses commonly start out as sole proprietorships or general partnerships. The reason being is these legal structures provide a good framework for businesses that are started prior to all the pieces being in place. These legal structures work well for small businesses, but as your business evolves and grows, it’s common for a different corporate structure to work better for your business. Changing your business legal structure can take a bit of time and effort, but the benefits tend to outweigh the costs. Here are some things to consider if you are thinking of changing the legal structure of a business.
Changing the structure of your business usually makes sense as your company grows, or when you change the focus of your business. For example, if you began as a sole proprietorship and now want to hire a couple of employees this is a good time to consider a different business structure. Another example, if someone beginning their business as a hobbyist or side venture that grows into a full-time job. You might also want to consider changing your business structure if your business acquires significant assets.
Changing the structure of your business can have both financial and legal advantages including:
Typically, changing your business structure will make financing easier, especially if you are looking to grow your business, get a loan, or purchase large assets. In many cases banks and other lenders prefer to work with businesses that have a separate legal structure. Additionally, if you are looking for potential investors for your business, you are likely to have more success if you’re business is incorporated or is an LLC as opposed to a sole proprietorship. The reason investors prefer to invest in these types of businesses is because you are able to sell a portion of your business in exchange for capital investment which is not available to businesses structured as a sole proprietorship.
Changing your business structure from a sole proprietorship to an LLC, corporation, limited liability partnership, or another legal entity can have multiple benefits when it comes to liability. The most important benefit is that all of these structures limit your personal liability. If your business gets sued or cannot pay its debts, for example, creditors cannot come after your personal assets to satisfy those obligations. However, if you operate as a sole proprietorship or general partnership you are leaving yourself personally vulnerable.
It’s best to speak with your business account or financial advisor regarding the impact your business structure has on your taxes and what makes the most sense for your business. A C-Corporation, for example, can be taxed twice—once at the corporate tax rate and then again as you withdraw distributions. However, if you decide to form an LLC or S-Corporation, your tax obligations may not change at all.
In most cases, you won’t experience any changes to the level of control you have over your business. The only way you could lose control of your business is by bringing in new investors or shareholders that have a say in how you operate.