When is it time to convert your sole proprietorship?

A sole proprietorship may be ready to convert if the owner needs more protection against liability or if the business wants to raise capital.

Many businesses in New York begin as sole proprietorships, no matter the product or service they provide. For instance, a business that offers yoga lessons or delicious bakery treats could have started as a sole proprietorship (and might still be one).

Sole proprietorships carry a few advantages in that owners retain complete control of the business and taxation is simple. At the same time, there are disadvantages such as the fact that owners put both their personal and business assets at risk with a sole proprietorship. When is it time to convert a business into something such as a limited liability company or corporation?

As soon as possible

An easy rule of thumb is to convert a sole proprietorship as soon as possible. Otherwise, owners remain personally liable for any damages if the business is sued. A business could be sued for many reasons, including contractual disputes, fraudulent claims (even if unintentional) and plagiarism.

Bottom line: Once a business has proved its idea is viable and can afford to convert, it should do so.

When raising capital is necessary

Of course, not every business converts as soon as possible. Many hum along just fine for months or years without the threat of a lawsuit. However, there may come a time when the business needs to raise money.

Understandably, it is difficult to get investors for a sole proprietorship. After all, the business remains under the owner's sole control, and everything could be undone with a single lawsuit. By converting to a corporation, a business owner has a much better chance of attracting investors.

When a credibility boost would help

Becoming an LLC or corporation can also boost the credibility of a business among people other than investors. For instance, a business name that is "ABC Bakery Treats, LLC" carries the whiff of formality and legitimacy, thanks to the LLC. Vendors and other companies may be more likely to work with such an organization.

What to convert to

In many cases, sole proprietors prefer to convert to LLCs. LLCs are not as costly to form as corporations and still provide good protection against liability. There is also less taxation with LLCs.

Depending on the business goals, forming a corporation may make more sense than going the LLC route. Protection against personal liability is even stronger than with LLCs, and standards for reporting and record-keeping are higher. Corporations also tend to be more attractive to investors.

It can be confusing to decide whether a business should become an LLC or a corporation, and if so, what type. A lawyer in New York can help business owners through the entire process.