Is it possible to convert your business from its original entity type into another entity type? The short answer to this, of course, is a “yes.” Also known as statutory conversion, business entity type conversion is the legal process by which a company changes from one entity type to another.
However, those interested in pursuing this should note that entity type conversion is only permitted in some states across the country.
So why is it necessary in the first place? How does a company do this right and who can help them out? We’ll address these topics and more in this article, so read on…
What is entity type conversion and why should a business consider it?
Simply defined, this is the legal process by which a company’s existing entity is changed into another. Through this, a business entity designation is converted without needing to dissolve it or to create a new one.
For instance, a limited liability company may convert into a corporation – or a sole proprietorship may convert into an LLC. In any case, the business’ legal structure will be converted without having to comply with business formation or dissolution requirements.
Companies have different reasons why they decide to change their entity structures. Generally, the most common reasons include saving on taxes, attracting more investors, and expanding a growing business.
As pointed out by the US Small Business Administration:
“Your business structure affects how much you pay in taxes, your ability to raise money, the paperwork you need to file, and your personal liability.”
Meanwhile, BizJournals emphasizes that “an entity conversion enables you to change the type of entity your business organization is.”
The business news website likewise adds that statutory conversion “will not help you move your company from one state to another nor will (it) enable you to do business in another state” since there are different processes for those.
States usually have different rules on entity type conversion. However, it is usually filed with the Secretary of State and may be a fairly simple and inexpensive process.
Again, not all states allow entity conversion so it’s always best to seek expert guidance. Lawyers, accountants, and business advisers can provide you with valuable insights on which entity type is best for your business. Moreover, you may also consider hiring a registered agent service to handle the filing of necessary paperwork.
Some of the advantages of entity type conversion
Of course, there are certain benefits that come with changing a business’ entity type. Consider the following:
1. The business owner may not be held directly liable for the business’ debts and obligations
The US Chamber of Commerce shares one example:
“Many business owners start their business as a sole proprietorship… The owner of a sole proprietorship is personally liable for the debts and obligations of the business. If the company were to go bankrupt, for instance, the founder/owner would have to pay all outstanding debts out of their personal savings.”
A growing business inevitably faces greater risks. That’s why a business owner “may not want to be personally responsible for the obligations of the company,” added USCC. As a solution, it is recommended that the business’ sole proprietorship structure be converted into an LLC or a corporation.
2. Most investors consider a business’ entity type before funding a company
As mentioned earlier, a business’ entity classification often affects its capability to attract potential investors.
According to Score.org, some investors “want to minimize their risk while maximizing their returns.” For this reason, they “prefer to fund business entity types that shield them from liability.”
The site further explains:
“Angel investors may want a significant ownership share of the business and control over how the business is run. Venture capitalists usually want to see high growth quickly and expect to have some control over business decisions.”
In reality, banks also prefer companies with a formal structure when it comes to approving loans. It is, again, worth mentioning that experts can guide you in determining which entity type is perfect for your company.
3. It can lighten your tax responsibilities
Another perk of statutory conversion is that when done right, it can help significantly reduce a company’s obligations, tax-wise.
However, the USCC reminds business owners that while avoiding debt with the Internal Revenue Service is impossible, selecting the right entity type “can help alleviate” your tax burdens.
Research is definitely the key to a successful entity type conversion process. You can check out local and state government websites to learn about the requirements for you to change your structure without hassle.
If you need help with filing your conversion documents or in obtaining a certified copy of your Certificate of Conversion, don’t hesitate. A registered agent can be a useful resource. With their expertise and knowledge, you can look forward to a speedy and seamless experience as you change to the right entity type that matches your business needs.