Can You Change Your Business Structure
Can you change your business structure? There are many situations in which it makes sense to change a business structure.3 min read
Can you change your business structure? There are many situations in which it makes sense to change a business structure. With a different business structure, your business may be more successful. Perhaps your partnership or sole proprietorship could use more liability protection? If so, you may want to consider a different business structure. However, it's important to understand all of your options before making any changes.
Main Reasons for Changing Business Structure
Forming the legal business structure of an entity is not a one-time proposition. As a business grows, evolves, and changes, it may be wise to update the company's legal structure. And in many cases, it's actually quite easy to modify the structure of a business.
The most common type of change occurs when a simple partnership or sole proprietorship changes to a limited liability company (LLC) or a corporation. When a company is initially started, the owner(s) will select the business structure that is ideal for them at the time of creation. Many small business owners will select a simple partnership or sole proprietorship because it will meet the needs of the company.
If a business structure was never established by a business with only one owner, then the default structure will be a sole proprietorship. Simple partnerships and sole proprietorships are typically the default business structure because they don't have to be registered. Although they're both easy to manage, they do carry some limitations.
Generally, simple partnerships and sole proprietorships are designed for businesses that have no employees and only one or two owners. Also, the two structures don't offer any personal liability protection for the owner. As a business grows, it's important to create a strategy to safeguard personal assets.
According to the Small Business Administration (SBA), "Businesses typically change their legal structure because of a change in business need." Common reasons for making the change include decreasing personal liability risk, increasing potential growth in the business, and decreasing tax liability. A company may decide to make a business structure change because of the following reasons:
- Company growth: A business will usually change its business structure when it realizes that it has outgrown the benefits of the initial structure. For example, if a small construction company began as a partnership or sole proprietorship and eventually moved on to larger, more dangerous projects, changing the business structure to a corporation or limited liability company (LLC) would provide increased personal liability protection for the owners. Remember that a restructuring is recommended when personal assets of the owner(s) may be in jeopardy due to potential liability of the business.
- Liability protection: A corporation or an LLC will offer more protection for an owner's personal assets.
- Tax considerations: Individuals preferring to move their tax liability from a pass-through entity to a corporate tax structure will change their business entity type to a corporation. A corporation may lower its current tax liability by retaining income and keeping it in the organization. A pass-through entity pays taxes on the annual total net income and it's funneled through the owner's personal tax return. These entity types include:
- Sole proprietorships
- Employees: Businesses that have employees will see their complexity and overall business liability increase. Remember, it's important to consider a business structure that may protect you from potential lawsuits.
- Going public: A small business may look to raise capital by becoming a corporation and selling shares of the company to the public. Most investors will prefer becoming a partner in a business that has a formal structure. A formal structure will help attract the right type of investors for your business.
- Change in ownership: Increasing or decreasing the number of owners in a business will typically cause a change in an organization's structure.
- Need for additional financing: Many banks will request to see a company's formal business structure before approving them for a loan. Without one, a business may not be approved for financing. Creating a formal business structure tells the public that you're taking your business seriously and portrays a level of legitimacy.
What Structure Should You Choose
Before selecting the appropriate structure of a company, it's recommended by the SBA to analyze these five characteristics of the business:
- Fees and forms
- Operational continuity
- Investment needs
If you need help with determining if you can change your business structure, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.