The first question should be which type of business structure makes the most sense for your business. Both sole proprietorships and LLCs come with advantages and disadvantages. That said, if you are currently a sole proprietor and are looking to switch your business structure to a Limited Liability Company, there are steps you will need to follow and documents that must be submitted to make the transition a more seamless one. In this article, we take a look at some of the requirements involved with switching from a sole proprietorship to an LLC.
Understanding the Differences Between a Sole Proprietorship and an LLC
For the most part, sole proprietorships are owned by a single person. In some instances, a married couple can own a sole proprietorship. As far as the advantages of this type of business entity, it is the easiest and cheapest to establish. So when first starting out, many companies opt to go this route. On the downside, there is no separation between the business and personal; meaning, personal assets can be seized if the company owes creditors and has to subsequently pay damages because of legal action.
An LLC can be owned by a single member or it may also be owned by multiple members. And while they are more expensive to set up as well as requiring more paperwork, the advantage here is that there is a division between the business and the personal. Members are thus protected from the company's liabilities. With an LLC keep in mind, the tax responsibility will be shared between all members.
Switching from a Sole Proprietor to LLC
As your business expands, it might make sense to switch to an LLC. You of course want to be able to protect your assets; not to mention, the fact that an LLC does give you a better format for growing your organization. Below are six steps that will help you move from a sole proprietorship to an LLC.
1. Have a unique business name
Unlike with a sole proprietorship, you will need a legal business name that is not already in use by another LLC or corporation in your state. So even if you have been using a name up until this point as a sole proprietor, if it is taken, you will have to select another. There are a couple of ways to check your name. You can call the relevant state office; you can also usually access an online database of registered business names to see if yours is currently in use. Often, companies will hire a lawyer for this task as well.
Keep in mind too, the name that you use will have to include the words Limited Liability Company or you can opt for an abbreviated LLC or Ltd. The name itself is most often automatically registered upon you filing the requisite paperwork with your state.
2. Fill out and file the articles of organization
Any LLC will have to file what is called articles of organization. This is an official form that you can usually get from your secretary of state's office. The articles outline all business information, so for example your business name as well as address and owners' names. The document is relatively short. When submitting the articles, you will need to pay a fee—this will range depending on your home state.
You will also have to list a registered agent who is eligible to receive paperwork on behalf of the LLC. If you are the sole owner, you can be that registered agent. If it is a multiple-member LLC, one of you will need to be designated as the agent.
3. Come up with your operating agreement
While this is not a document that needs to be submitted to any state agency, you should always have an LLC operating agreement in place. This essentially outlines how ownership is structured, how the company will be managed, and how general operations will unfold. The LLC operating agreement might also contain information regarding voting rights, distribution of profits and losses, as well as member responsibilities. The reason for such an agreement is mainly to stem any conflicts before they arise. With a multiple-member LLC especially, this document is pretty important to that end.
4. Publish notice of your LLC
In several states, you will have to publish notification that you have filed to become an LLC. Most businesses will do this in their local papers. And in some states, the requirement is that you publish an announcement of your LLC more than once. Each state will differ as far as how many times you'll have to publish, so be sure and check on your state's specific requirements.
5. Get a bank account for the LLC
As a newly established business (one separate now from the owner/) you will want to create a bank account in the business's name. This helps you distinguish more effectively between personal and business finances. And again, it does go toward protecting your assets. Not to mention, for reporting purposes, it just makes good business sense.
6. Obtain any licenses and permits
If your specific business requires certain licenses and permits, you will need to refile for these now under the LLC. This could be a general business license, seller's license, or zoning permit for example. Also keep in mind, that the company will need also to apply for a new employer identification number for the LLC.
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