Entity Formation | Form Your Business in the United States

When to Convert Sole Proprietorship to LLC or Corporation

Most entrepreneurs start small with the goal of becoming big. Understandably, businesspeople begin by creating a sole proprietorship. Eventually, though, it becomes more practical to convert your sole proprietorship to a limited liability company (LLC) or corporation. So when do you decide to convert?

There is no specific answer as to when exactly you should convert your sole proprietorship to an LLC or a corporation. But, when the company is getting bigger, it is more practical to turn it into an LLC or corporation. If you are not yet comfortable about becoming a corporation, an LLC will do.

The basic reason why an entrepreneur should convert the business is for the company to be treated as a separate entity. In a sole proprietorship, the owner’s money and responsibilities are merged with the company. So if there are business impediments—like a legal or financial one—repercussions affect the personal and business aspects. For example, the business is being sued. If the business is under a sole proprietorship, you, as owner, will be named respondent of the case. However, if the company has been registered as an LLC or corporation, the LLC or corporation will be named respondent of the case.

It is also worth noting that if the company is being sued for financial purposes, under the sole proprietorship, it is the owner who will shell out the money. But under LLC or corporation, the business’s own funds will be used for pay off whatever financial responsibility is raised. So basically, incorporating the business protects the owner/s of the company.

Another answer to the question of when to incorporate is when you feel like the business is getting financially volatile or when you foresee the possibility of multiple cases in the future. Of course, you should try to avoid any form of a lawsuit, but if you expect it anyway, then there is no sense in waiting to incorporate.

There is one school of thought that answers the question of when to incorporate with: AS SOON AS POSSIBLE. This is because it is always best to start the business the right way. And by right, that means giving that business its own personality. But be practical about it though. Even if you want to incorporate right away, you should probably wait until January. This is for purposes of filing tax returns. If in a year the business has operated as sole proprietorship and LLC or corporation, then you have to file tax return for both.

As for choosing between converting to LLC or corporation, this is something you need to think about intelligently. You have to consider the pros and cons seriously. But here is a simple differentiation: the LLC will die along with the owners or partnership. Or the LLC will be dissolved in cases of bankruptcy. However, a corporation can live on forever despite the loss of the founding members. It is also a better option when you plan to issue or sell shares in the future.

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