Many entrepreneurs just getting started will incorporate as sole proprietorships, due to its affordable nature and the ability the entity offers to exercise complete control over the business. It's not uncommon for an entrepreneur to start off incorporated as a sole proprietorship (or as any other entity) and then consider switching over to a formation that might be a better fit for their growing business. So is it possible to switch entities after initially incorporating? The short answer is yes—but this is also a conversation worth having with your accountant or legal adviser first to seek further advisement and answer any questions you may have about the process. Once you have made that a priority and determined you are ready to change your business formation, here's what you should keep in mind as you consider switching over to a new entity.
1. Objectively weigh the pros and cons of each entity.
According to the IRS, the five most common business structures are sole proprietorships, partnerships, corporations, limited liability companies (LLCs) and S corporations. Let's take a closer look at the benefits each offers your business, by way of tax and credibility advantages.
This is one of the more common business formation types due to its affordable nature and the benefits of being your own boss. If you want to exercise complete control over your business and work within a field where few liability risks are involved, incorporating as a sole proprietorship might be exactly what your startup needs. However, keep in mind that this entity does not separate personal assets from professional ones. Because there is no tax or liability assistance in place, a sole proprietorship holds the owner completely liable for everything that happens with the business.
Thinking about getting into business with a family member or friend? Explore incorporating as a partnership where you can share profits and losses together. Here you'll be able to make decisions with the express consent of all other partners involved, but be careful—this entity holds each partner liable for the decisions, as well as actions, made within the business.
If you've got big plans to expand and (eventually) go public with your business, a corporation might be your best formation bet. You'll be able to keep your professional and personal assets separated and establish a structure that makes it possible to issue shares and accept money from investors.
Much like corporations, LLCs also keep personal and professional assets separate in the event of unforeseen circumstances. As an LLC, you will also receive major tax advantages, including saving money on taxes and choosing your own tax entity—either as an S corporation or a C corporation.
S corporations pass net profits and losses along to shareholders via a “pass-through" structure that is only taxed once at the shareholder level instead of twice.
2. Begin filing an article of amendment.
Once you've determined the entity you want to switch over to, the next step is to file an article of amendment. Also known as certificates of amendment, most states require any incorporated business making changes to file these documents. Aside from switching entities, you may also file an amendment when changing the following areas for your business:
- The names and address of directors or members
- Your office address
- The name and address of the registered agent
- The number of authorized shares
- The description of business activities
What if you are an LLC that wants to switch over to be a corporation strictly for corporate strategic changes like tax reasons, issuing shares or going public with your business? In this case, you would file a conversion with the state instead of an article of amendment. Most states require Articles of Conversion, Articles of Incorporation and the filing fee as required documents to accompany the new entity formation filing.
3. Document all changes made throughout the conversion process.
While these changes will be documented with the state through an amendment, it is also important that any changes or additions made to the legal formation are documented in your corporate ledger. Consider:
- Adjusting items by documenting them with minutes in your corporate minute book.
- Tracking changes to your entity at your annual meeting and document any changes with resolutions.
- Making notes on your annual report of any changes made to owners, officers or directors of the business along with whether or not the company moved.
Whether you are converting entities simply for strategic changes or switching over to new legal formations altogether, check in with your lawyer or legal adviser before you begin to ensure you are making the best possible decision for your business in the long run.