Steps to Make the Transition from a Small Business to a Company
Many businesses start out small, usually as a sole proprietorship, but over time, hopefully, the business will grow. At some point, you may want to transition from a sole proprietorship to a limited liability company (LLC) or a corporation.
Many businesses at this stage choose an LLC because it has many benefits and is less complicated than a corporation. Here will discuss how you can change your sole proprietorship to an LLC.
What Is an LLC?
An LLC offers liability protection for owners and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes.
As a “pass-through” entity, income passes through the business to the owners, who report it on their personal tax returns on a Schedule C. An LLC is created by filing paperwork with your state, and nominal fees are involved.
Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning their personal assets are not at risk if the business cannot pay business debts or is involved in a lawsuit.
Select Your LLC Name
As a sole proprietorship, your business name is your name, unless you have a dba name. Now you need to choose a name for your LLC. Your business name is the first impression people will have of your company, so it’s very important.
You’ll need to make sure the LLC name you choose is not already taken. First, do a search on your state’s website to make sure no other LLC has the same name in your state. You should also check the US Patent and Trademark Office to make sure the name hasn’t been trademarked.
Then do a domain name search to make sure that you will be able to use your name for your website. You can do a domain search through web hosting sites such as GoDaddy.
Finally, just search the web to make sure that no one is using your name or something similar anywhere.
There are some rules you need to follow when naming your LLC, which vary by state. Generally, you must use “LLC” or “limited liability company” in your business name.
Also, your name cannot be something that could be confused with a government agency, or make you appear as though someone in your company has a particular license if no one does. Every state has different rules, so check your state’s website.
Select a Registered Agent
A registered agent is the person or company that sends and receives legal documents on behalf of your LLC. The registered agent can be a member of the LLC, or you can choose a third party such as a registered agent services company.
Most states require you to have a registered agent. The agent must be a resident of the state where you do business, or a corporation authorized to do business in your state.
Decide on a Management Structure
There are two types of management structures:
- A Member-Managed LLC is managed by the members of the LLC. This is usually chosen by smaller LLCs with few members who will be involved in various management roles.
- A Manager-Managed LLC is managed by people who are not members of the LLC and are employees of the business.
Some states require that you state your management structure in your LLC filing paperwork, and some do not.
File Articles of Organization with Your State
The articles of organization is the form that Iyou will fill out to form your LLC. In some states, it is called a Certificate of Organization or a Certificate of Formation.
These forms vary by state but can generally be filed online. You’ll need to fill out the LLC name, the name and address of the registered agent, the names of the LLC owners, and in some states, the way the LLC will be managed. Fees vary by state and range from $70 to $500.
Draft an Operating Agreement
An operating agreement is not usually required but is highly recommended. The operating agreement should clearly define the following:
- The percentage of each member’s interests in the LLC
- How profits and losses will be allocated to each member
- Each member’s rights and responsibilities
- The management structure and management roles of members
- The voting rights of each member
- Rules for meetings and voting
- What happens when a member sells their interest, becomes disabled, or dies
It’s a good idea to have an attorney’s help when creating your operating agreement so that you can be sure you’re covering all bases.
If your business is growing and you’re ready to take it to the next level, forming an LLC is probably the right next step. An LLC has many benefits, particularly in terms of the personal liability protection it offers.
By keeping your business a sole proprietorship, you don’t have that protection. If you’re unsure about what type of business entity to form, consult with your tax advisor.