28 July 2019 by Kiely Kuligowski
Your business structure is the cornerstone of your company. It is likely one of the first things you decided on when you created your business and, since then, has guided many of your business decisions.
- It is possible to change your business structure at any point.
- A change in structure requires careful consideration, planning and consultation from professionals and colleagues.
- Make sure you are aware of all the ramifications of switching and not switching before finalizing your decision.
Your business structure (LLC, S-Corp, C-Corp, etc.) determines the level of control you have over your company, the taxes you pay and how your business operates day-to-day. When you are in the early stages of launching your business, choosing a business structure can feel like a permanent decision, considering everything it determines. However, just like life, things change. Industries grow and shrink, perhaps you want to minimize your tax liabilities, or you may even want to reduce your exposure to potential liability. It is possible to change your business structure to better suit your changing business needs.
Types of business structures
To change your business structure, you must first know what type of business you are changing to. There are four main business structure options:
- Sole proprietorship
- Limited liability company (LLC)
Many small companies start as a sole proprietorship, which is the simplest and most common way to start a business, according to the U.S. Small Business Association. A sole proprietorship is an unincorporated business owned and run by one individual who is entitled to all profits and responsible for all business debts, losses, and liabilities.
Another structure is a partnership, which can be as simple or as complex as the business owners make it. You may have an oral “handshake deal” or a written partnership agreement that outlines the basis for the partnership, business expectations, liabilities, etc. A business partnership can have two or more business partners; however, more partners can mean more complications in making business decisions.
A Limited Liability Company (LLC) allows you to take advantage of the benefits of both a corporation and a partnership. LLCs offer greater protection from personal liability in most cases by sheltering your personal assets, such as your vehicle, house, or savings accounts, if your LLC runs into bankruptcy or lawsuits. Profits and losses flow through to your personal income without facing corporate taxes, though, but LLC members are considered self-employed and must pay self-employment taxes.
A corporation is a company or group of people that are authorized to act and legally recognized as a single entity that is separate from its owners. Corporations come in two types: C-Corps and S-Corps. C corporations are subject to double taxation, where the company is taxed before and after the distribution of dividends. S corporations are the most common corporate structure for small businesses largely due to the exemption from double taxation. Corporations also offer the largest degree of protection from personal liability but are costly to form and require extensive record-keeping.
When to change your business structure
“It is 100% possible and [often] a good idea for some business owners to change the business structure,” said Matthew Meehan, CEO of Shield Advisory Group. But be sure that you are doing so for the right reasons.
A common motivation for changing business structure is taxes, whether that’s saving or simplifying tax filing, or to increase your legal protections as a business owner. Many businesses also change their structure when undergoing significant changes, like hiring, or seeking outside investment or financing.
“More often than not, a business will decide to change its structure because the needs of the business are changing and you are beginning to outgrow your existing structure,” said Deborah Sweeney, CEO of MyCorporation and business.com community member. [Are you writing a business plan? You may find business plan software helpful. Check out our reviews and best picks.]
Consider a change when you see clear evidence of opportunities that you cannot capitalize on due to your current structure, said Martin Calvert, marketing director at GreyClaw Marketing. “Changing the structure of a business can be highly effective, but there will be inevitable disruption, so knowing why this change is required is key,” he added.
Another reason for a change in structure, particularly for sole proprietors, is greater business credibility. Many customers will take a business more seriously if it has a strong, flexible legal structure.
If you are questioning if a change is necessary, sit down and review your reasons for wanting the change, how it benefits the company, potential drawbacks to making the change, and what is required of you (and the business) to make it happen.
Consult a professional during this process – most experts agree it is not something that should be done on your own.
“When changing your company structure, you must talk to your tax advisors, because you want to avoid unnecessarily triggering a tax event,” said James Cassel, chairman and co-founder of Cassel Salpeter & Co. “You have to talk to both your tax lawyers and your accountants so you fully understand what the ramifications of the change might be.”
How to change your business structure
The first thing you should do is check with your secretary of state and a tax advisor about regulations regarding businesses to see what steps and paperwork is required. Make sure that that you know what new licenses, insurance or registration the new structure will need, if any. Your tax advisors can guide you through this process.
Then inform all of your employees – if any – what the change will be, how it will be implemented, and what the short- and long-term effects will be.
Charles Floate, founder and CEO of DFY Links, advised that any structural changes be implemented slowly.
“The change should be staggered,” he said. “Otherwise, flipping the business structure upside down in one fell swoop can make things twice as bad.” Floate encouraged making the most important changes first and allowing them to settle before moving on to secondary changes to ensure a smooth transition for everyone. [See related article: How to Change Your Business Structure]
What not to do
There are many things to be aware of when changing your business structure. And because it is your own business, you have a strong personal stake in ensuring that you steer clear of legal and/or financial trouble. As such, do not change your business structure on your own. Consult experts outside of your company, as well as partners and/or employees.
“A structural change to a company should never be done a whim,” said Calvert. “Or due to ego or the personal opinion of one individual, even if that individual is the CEO.”
By consulting numerous individuals both within and outside of your company, added Calvert, you are more likely to understand the implications of inaction and the outcomes you realistically hope to achieve by changing your structure.
Cassel said that the most common mistake he sees with businesses altering their structure is choosing the wrong type of entity for tax purposes.
“You [also] have to be very careful when you are restructuring for tax purposes. Sometimes if you change the entity but later want to change it back, you may encounter limiting factors and even potential penalties,” he said.
Be confident in your change and why you are making it, and have evidence that it will push the company forward.