Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
Are you thinking of converting your sole proprietorship business into an LLC?
Timing is everything, and if your venture is ready to go to the next level, you need to switch at the perfect moment. Otherwise, you might compromise your security and prosperity. If you are unsure about the timing, here is a guide to help you out.
When You Should Form an LLC
Below are some common signs that it might be time to form an LLC for your business.
You Want to Take on Some Risk and Grow Your Business
Are you ready to take on risk to expand your business? Then it might be time to form an LLC. LLCs provide personal liability protection, so if there are any issues or the deal goes wrong, creditors will not come after your assets. You won’t be held responsible for the losses.
You Want to Raise Capital
As a sole proprietorship business, it is challenging to get funding to finance new projects. Banks and investors rarely pour large sums of money into sole proprietorships because they view them as personal enterprises, not highly profitable businesses.
Even if you get the funding, it will be a small amount (personal loan) compared to what an LLC would get (business loan).
You Want to Expand Without the Complexities of Corporations
LLCs provide some of the benefits of corporations without the associated complexities. It will be an easy switch for sole proprietors because an LLC has few formal annual requirements and no regular meetings to maintain corporate status, unless your LLC is taxed as a corporation.
Another benefit they have over corporations is that they are pass-through entities. The pass-through feature implies you can deduct business losses from the personal tax return.
Also, the IRS allows you to select whether to be taxed as a partnership or corporation. You can compare both taxation methods to determine which one gives the best tax benefits to your business.
Additionally, LLCs can avoid double taxation. LLCs taxed as disregarded entities (sole proprietorships), partnerships, and/or S-corps avoid double taxation. An LLC can be taxed as a C-corp and still be subject to double taxation. With corporations, the IRS first taxes the net profit. After the shareholders distribute the income, the IRS taxes each one at an individual level. We know all of this information can be relatively confusing, so for a deeper breakdown, head over to our guide on taxes for LLCs.
Related column: What is a disregarded entity?
You Want to Make the Business a Substantial Legal Entity
Having the abbreviation LLC in the business name is advantageous because the entity appears more official. It shows the state has registered the business, which gives investors, banks, and clients a higher level of trust in what you are running.
Advantages of Forming an LLC
Here are some of the additional benefits of converting your enterprise from a sole proprietorship into an LLC.
Protect Your Assets
Perhaps the best advantage of forming an LLC is the personal liability protection, which means your commercial properties, cars, house, and savings are usually safe from creditors. However, if the business owner pierces the corporate veil, that liability protection goes away.
The new structure separates you from the business, which means if the LLC faces lawsuits or bankruptcy, it deals with the law as a separate entity. Only the assets directly tied to the enterprise will be at risk.
Protect Your Privacy
It is not possible to separate a sole proprietorship from its owner. If anything goes wrong, your privacy will be at stake.
For instance, if the business gets sued, you can expect a lot of personal information, such as your home address and contacts, to come into the open. However, an LLC will not expose you because it is a separate entity.
Promote Business Growth
Since you will be able to raise more capital from banks and investors as an LLC, you can accelerate business growth by acquiring more assets, expanding production, or venturing into new markets.
As stated earlier, LLCs appear as more reliable and established business entities as compared to sole proprietorships. Therefore, your business will gain more credibility.
For more on this topic, head over to our guide on LLC pros and cons.
When You Should Not Form an LLC
Even though LLCs have multiple benefits, sometimes they are not the best solution. If your sole proprietorship business is getting along just fine, your personal risk is minimal, and you do not see a need to expand operations, you can probably hold off on forming an LLC.
For instance, if you offer your services as a virtual assistant or freelancer online, you can keep it that way until you get a solid expansion plan.
Remember that LLCs require a little more paperwork and better management, so if you want to keep it simple, maintain it as it is.
In addition to the paperwork, LLCs need more money to run. Consider the LLC registered agent fees, LLC registration costs, legal fees, and other expenses. If you don’t have the financial resources, there is no need to convert.
Steps for Converting Your Business Into an LLC
If you feel it is the right time to take the next step, and the advantages of an LLC greatly favor your business, you can take the steps below to form your LLC. You can also get a service to do it for you, so be sure to check out our top picks for the best LLC formation service to find the best options.
Name the LLC
Pick a unique LLC name that is not in use in your state. It should not infringe on existing copyrights or include restricted words like insurance or bank.
Select Your LLC Registered Agent
Pick your LLC registered agent, who will be the person representing the business. The agent will accept all legal and tax documents on behalf of the LLC.
Create and File the Articles of Organization
The Articles of Organization is the official registration document of an LLC. Depending on the state, it might be the Certificate of Formation or Organization. After creating and filing it, pay the registration fees.
Publish a Notice of Intent to Create the LLC
Some states require businesses to publish a legal notice in a local newspaper to announce the intention to form an LLC.
Create an Operating Agreement
An operating agreement is a legal document that highlights the ownership structure and duties of each member.
Get an EIN
An Employer Identification Number is like the social security number for a business. Any sole proprietor that incorporates into an LLC must get a new EIN.
The Last Word
Overall, the most crucial factor to consider before going forward with this move is liability protection. It is better to convert into an LLC than to need its protections when it is too late. After you form your LLC, head over to our guide on – I have an LLC…now what? Questions? Let us know.
Filed under: Advice Columns