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When is the Right Time to Convert From Sole Proprietorship to a Corporation?

Research and observation shows that, when they succeed, businesses have certain natural stages of growth. Many a San Diego business might start off as a sole proprietorship. That is, the business is/was just you (with the occasional help of family and friends). As your business grows, there will come various points in the normal growth cycle when it may be time to convert from a sole proprietorship to a corporation or an LLC. We call these “natural growth points.” Here are a few examples.

San Diego Corporate Law: When You Expand the Number of Owners

The first natural growth point is when you expand your business with new owner(s). Yes, your sole proprietorship can simply morph into a general partnership, but it is not business savvy to be passive about your business structure. You and your new partner need to hammer out an understanding with respect to many aspects of the business including:

Division of responsibilities
Management and control
Expectations for the “direction” of the business
Getting paid and taking draws from the business account
Capital and other types of contribution to the business
Dissolution of the partnership/business
And many more issues

Some sort of founders or owners or pre-incorporation agreement is needed so that you all know you are on the same page and have the same expectations. This is an ideal time to convert to a more solid corporate foundation for your business. A good corporate attorney can help.

San Diego Corporate Law: When You Hire Your First Full-Time Employee

Another natural growth point is when you expand your business by hiring your first full-time employee. Hiring a full-time employee requires extensive compliance with labor and tax laws with respect to labor reporting, tax withholding, required notices, unemployment and workers’ compensation insurance, and the like. Your potential litigation risks expand exponentially with your first employee; you and your business are now at risk for various employment-related lawsuits including wage actions, discrimination, harassment, wrongful termination, and similar.

San Diego Corporate Law: When You Buy Your First Real Estate

In the same manner as when you hire your first full-time employee, a natural growth point is when you buy your first piece of real property. As with employment law, your potential litigation risks expand exponentially with owning land. Insurance coverage will take care of most of the risk, but adding the layer of protection that comes with a corporation reduces the risk even more.

In addition, with real property, there are significant tax expensing and planning options with a corporate entity. For example, you can hold title to the property in your individual name and lease to the business. Sometimes that provides tax advantages.

San Diego Corporate Law: When You Need Financing Based on Business Assets

As a sole proprietorship, any financing you may receive is based on your personal credit rating. There comes a point at which you want your financing and capital investments to be based on business assets and business credit rating. In practice, lenders will want a formal business entity formed before making the loan.

San Diego Corporate Law: There are Now Actually Personal Assets to Protect

A final natural growth point is when your business is successful enough that you can run the business without resorting to your own personal assets. When this milestone is reached, it becomes essential to protect those personal assets. Maybe there is a mistake or an accident at work and then there is a lawsuit. If the accident is a business accident, then you want any judgment to attach to business assets, not to your personal assets.

Contact San Diego Corporate Law Today

If you and your business have reached one of these growth points or you want more information on forming a corporation or a limited liability company, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has the experience to help you form a corporation (or any other corporate entity), including drafting custom bylaws, ownership agreements, and buy-sell agreements. Mr. Leonard can be reached at (858) 483-9200 or via email.