Key Takeaways

  • Business owners often need to convert a business structure as their company grows, tax situations change, or liability risks increase.
  • Conversion can occur from a sole proprietorship or partnership to an LLC or corporation, or even from a corporation to an LLC.
  • States generally allow either statutory conversion (simpler) or statutory merger (requires forming a new entity).
  • Common triggers for conversion include adding partners, seeking financing, attracting investors, liability protection, or going public.
  • Steps often involve drafting a plan of conversion, board and shareholder approval, and filing conversion documents with the state.
  • Businesses should consider tax consequences, bylaws, and long-term growth goals before making changes.

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:
    • Partnerships
    • Sole proprietorships
    • LLCs
  • 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.

Legal Methods to Convert a Business Structure

Converting a business structure is possible in most states through two main approaches:

  • Statutory conversion – A direct, streamlined method where the existing business entity becomes the new entity. Assets, liabilities, and contracts automatically transfer, avoiding the need to dissolve and recreate the business. This is the preferred route where available.
  • Statutory merger – Requires creating a new entity (e.g., an LLC) and then merging the old entity into it. While effective, it is more complex and often unnecessary in states that permit statutory conversions.

These legal pathways ensure continuity of the business, meaning contracts, property ownership, and debts remain intact under the new structure. However, owners should review state law carefully, as some states require unanimous consent from members or shareholders, while others allow majority approval.

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:

  1. Taxation
  2. Liability
  3. Fees and forms
  4. Operational continuity
  5. Investment needs

Practical Considerations Before You Convert a Business Structure

Before moving forward, business owners should weigh practical issues such as:

  • Tax implications – Some conversions may trigger recognition of gains or losses. Consultation with a tax adviser is strongly recommended.
  • Financing and investors – Lenders and investors often prefer formal entities like corporations or LLCs for credibility and liability protection.
  • Operational flexibility – LLCs often provide more flexible management options, while corporations have stricter governance but may be more attractive to venture capital.
  • Costs and fees – Filing fees vary by state; for example, Florida charges $150 for filing conversion documents.

Changing structures should not be done lightly, as it impacts ownership rights, taxes, and daily operations. Careful planning ensures the conversion benefits the business long term.

Steps Involved in Converting a Business Structure

The exact process to convert a business structure depends on the state and entity type, but common steps include:

  1. Review governing documents – Check existing bylaws, partnership agreements, or operating agreements for provisions on conversion.
  2. Prepare a plan of conversion – Outline how ownership interests (such as stock) will translate into new membership or shareholder interests.
  3. Board and owner approval – Corporations usually require board adoption and shareholder approval; LLCs may need member consent.
  4. File with the state – Submit Articles of Conversion (and new Articles of Organization or Incorporation) to the Secretary of State or similar office.
  5. Address tax consequences – A conversion can change how profits are taxed. For example, converting a C corporation to an LLC may create immediate tax liabilities, while converting a partnership to an LLC usually does not.

Frequently Asked Questions

  1. Can I convert a sole proprietorship into an LLC?
    Yes. This is one of the most common conversions. It involves filing formation documents with the state and, in some cases, transferring business licenses and assets into the new LLC.
  2. What is the difference between statutory conversion and merger?
    A statutory conversion is a direct change of structure recognized by state law, while a merger involves creating a new entity and transferring assets and liabilities into it.
  3. Will converting a business structure affect contracts or debts?
    No. In most cases, contracts, property rights, and debts remain intact under the new structure, though you may need to notify banks or vendors.
  4. Do all owners have to agree to convert the business structure?
    Not always. Some states require unanimous approval, while others only require majority consent, depending on governing documents and state law.
  5. What are the tax risks when converting a corporation to an LLC?
    This can trigger significant tax liabilities, including recognition of built-in gains. A tax professional should review the impact before filing conversion documents.

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