Author: Kelly Zhou, Trusli
We will discuss why businesses want to change the business type (most of the time, from a less complex structure to a more complex structure) and how to change the business type.
WHY businesses might decide to change
In a company’s early days, when there isn’t a lot of profit, it may simplify things to consolidate any business income on all of the founders’ personal returns. When the business starts to grow, it’s time to retain earnings inside the company to fund further growth. We will discuss the following reasons that a business might decide to make a change:
When you hire employees, take out loans, or provide products or services to customers, you may be exposed to extensive personal liability for business-related damages unless you have selected a business entity that limits potential liability to business assets.
For example, although a sole proprietorship is the most convenient way for you to start a business and owners do not need to bother with the requirements that come with other business entity types, you are personally liable for all losses and debts. On the other hand, owners of business entities (such as a corporation) are generally not liable for business debts or obligations. Thus, small businesses begin as sole proprietors and at some point decide to lessen their personal liability by forming a business entity that offers liability protection. We will discuss how to change from sole proprietorship to a corporation as well as how to change from sole proprietor to partnership in depth later.
Change in ownership
If you have been a sole proprietor, but now want to add one or more business partners, the business must change its structure to a partnership, an LLC, or a corporation.
Most often, owners change business types for tax reasons. There are two major types of taxation for business entities: pass-through taxation and double taxation. Pass-through taxation applies to partnerships, LLCs, and S-corporations. A pass-through entity is a form of business in which the business doesn't pay tax. The owners of the business pay the taxes through their personal tax returns. It is a common practice to avoid double taxation on corporate earnings. On the other hand, C corporations are subject to double taxation which means business owners are required to pay income tax on the business’s profits twice.
HOW to change business type
Once you’ve decided it’s time to change your business entity, you can begin the process. Get started with the following steps to learn how to change business types.
Step one: research business structure options
There are four main types of businesses: sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. To better understand different types of business entities and which one will work best for your company, please check out our previous article (https://www.trusli.com/blog/choosing-an-entity-for-your-startup) which listed the pros and cons of each entity type. It would be wise to weigh your business entity options before making a change to ensure that your desired entity is the best structure for your business.
Step two: consult an expert
Choosing the right structure for your personal financial situation can help alleviate some of the burdens. Consider changing your business entity? Find a lawyer to help you decide which entity best suits your situation: https://www.trusli.com/
Step three: file paperwork
One of the simplest ways is to dissolve and totally liquidate the assets of a business entity and then distribute the assets to owners (or shareholders, if applicable). Sometimes, converting to a different business entity instead of dissolving it would better serve the business objectives. Unfortunately, there is no one-size-fits-all solution. Always check with your Secretary of State to find out the exact process. Although we cannot list all the scenarios, we will discuss the nuts and bolts of converting a Limited Liability Company for illustrative purposes.
Step four: update your contacts
Everyone you do business with, including vendors, advisors, and customers, should be notified once you change your business structure. You do not want to leave them in the dark. You need to update your contacts as soon as possible, especially if the restructuring impacts them.
Can you change your LLC business type? And How?
You can change the LLC business type and convert an LLC to another business entity by approving a plan of conversion that contains the terms and conditions of the conversion. The members must approve the plan. Once the plan has been approved, then the converting LLC must file articles of conversion. If the LLC is converting to a limited partnership or a corporation, it will have to file the appropriate formation documents for that type of business.
How to change LLC to sole proprietorship?
If you, having a one-owner business, have listened to others “everybody should form an LLC” and realized that an LLC is not right for you or your business, you may wonder: can I change my LLC to a sole proprietorship? You sure can. Changing your business entity from an LLC to a sole proprietorship requires you to follow the steps of dissolution to close your LLC and reform your business as a sole proprietorship. Each state has slightly different steps and procedures for the dissolution of an LLC, but the steps are generally the same.
How to change LLC to LLP?
The owners of a limited liability company (LLC) are called members while the owners of a limited liability partnership (LLP) are called partners. In general, LLCs and LLPs share the same legal protection and tax benefits but an LLP can reduce a partner's liability so that some owners of the LLP can have more passive ownership with no management responsibility and limit their liability as limited partners.
In order to successfully change the business type and convert an LLC into an LLP, the following steps are necessary to be taken: first of all, you need to file the Articles of Dissolution with the state which will legally dissolve your LLC and allow you to form another business entity; you also need to create a partnership agreement (or similar terms, like Articles of Organization or Articles of Formation) detailing the name of the partners, each partner’s responsibilities, respective ownership percentage, how earnings are distributed, each partner’s authority, and provisions for triggering events; then you can file the partnership agreement with the Secretary of State.
How to change an LLC to a C corporation?
Given it is much easier to raise venture capital for corporations, it would be a great idea if you want to convert your LLC to a C corporation. Two documents are required to be properly completed and submitted to the State of Delaware: the certificate of conversion and the certificate of incorporation.
- Certificate of Conversion
The filing must state the following:
- The original LLC name
- The date and the state the LLC was first created
- The name of the corporation to be formed in the accompanying Certificate of Incorporation (see below).
- Certificate of Incorporation
The filing must have the following information listed:
- Company name
- Registered Agent’s name
- Registered Agent's address
- Number and type of stock authorized
- Par value of the stock
- Incorporator information
Once the Certificate of Conversion and the Certificate of Incorporation are executed and the Delaware Franchise Taxes are paid, the filing can be submitted to the state. Additional steps include drafting corporate bylaws; electing corporate officers and appointing corporate directors; holding an initial board meeting; and issuing stock certificates. You may also need to obtain a new Employer Identification Number (EIN) as part of the process of changing business type with the IRS.