How to Convert from Sole Proprietorship to an LLC (And 5 Reasons Why You Should)
If you’re a construction entrepreneur operating as a sole proprietorship, you’re in good company. Sole proprietorships are growing in popularity, amounting to more than 70 percent of U.S. businesses today. And it’s easy to see why: launching a new construction business in this manner is simple to do and requires few additional steps beyond registering a DBA, obtaining the necessary licenses and permits, securing your materials and getting to work.
This may make sense when you’re just starting out, but what about as your construction business grows? As you begin taking on bigger projects, generating greater revenue and even adding to your crew, your personal liability and risk only increases. In this case, forming an LLC (“Limited Liability Company”) might be a smart move because it shields your personal assets from liability and debt related to your business. In a worst case scenario, having your business structured as an LLC could prevent you from losing everything.
Could converting from sole proprietorship to LLC be a wise choice for your business? Here’s what you need to know to help decide, as well as a simple guide for making the switch.
Table of Contents
5 Benefits of Converting from Sole Proprietorship to LLC
Before we go into how to convert to an LLC, let’s discuss the why you should consider making the switch. Changing your business structure to an LLC will allow you to:
1. Protect Your Personal Assets from Liability
As a sole proprietor, there is no legal distinction between you and your business. If someone is injured on the job, comes after your business for unpaid debt, or sues you for damage to property, you’re personally liable. The suing party can go after your home, vehicles, jewelry, your kid’s college fund and more. You never want to find yourself in this position, especially as you take on the risk of larger, more complicated projects.
When you form an LLC, it separates you from your business by legally classifying it as a separate entity, protecting your personal assets from any liability and debt your business may incur. This is critical to ensure the security of your personal wealth, both for yourself and your family.
2. Add Additional Partners
Unlike a sole proprietorship, you can choose to operate as a single-member, dual-member or multiple-member LLC, meaning you can continue flying solo or add one or more owners to run the business. This could help you secure additional funding and add expertise to your team. As your business grows, you may want to add partners who can contribute new skills and expertise that you otherwise wouldn’t be able to do.
3. Enjoy Potential Tax Benefits
LLCs are considered “disregarded” or “pass-through” entities, so profits are taxed under the owner’s individual income tax as it would be with a sole proprietorship. Though converting from sole proprietorship to LLC won’t change the calculation of your income tax, it will allow you to:
- Potentially avoid tax audits. Filing your taxes as a sole proprietorship is more likely to raise red flags with the IRS, so filing as an LLC could save you many hassles and headaches.
- Reduce self-employment tax. As a sole proprietor or owner of an LLC that’s taxed as a disregarded entity, you must pay self-employment tax on your company’s entire earnings. However, LLC owners may choose for their business to be treated as an S corporation to reduce their tax burden. As an “employee” of the S corporation, you would only owe self-employment tax on the salary you pay yourself instead of the entire business profits.
4. Boost Your Professional Cred
Operating as an LLC can offer the enhanced credibility you need to land the projects that will continue moving your business forward (and with much fewer formalities than forming a corporation). In the eyes of the public and your potential business partners, there’s just something more legitimate about doing business with an LLC versus a sole proprietorship.
Why? As noted previously, anyone can get up and running as a sole proprietorship quickly and easily. On the other hand, setting up a recognized business structure like an LLC takes time, expense, forethought and competency — and, consciously or not, people understand that. It shows that you’re a serious, credible professional who spent the extra effort to develop a formal business entity.
In this respect, having LLC next to your business name instantly improves your trustworthiness and reliability, potentially giving you the edge over your competition and supporting the growth of your business.
5. Expand Your Construction Financing Options
Growing your construction business means having the ability to take on more, and bigger projects that also come with much greater costs. If you don’t have enough upfront cash to start your next project because you’re waiting on a backlog of pending invoices to come through, you’ll be left treading water. In these cases, sole proprietors often have a lack of contractor financing options. However, if you convert to an LLC, it will put you in a better position to access financing solutions such as project-based material financing that will help overcome cash-flow issues and grow your business.
If converting to an LLC sounds right for your business, it’s time to start thinking about what you need to do to make the switch. (Pro tip: ZenBusiness offers free, helpful resources that contain a trove of valuable information for forming and growing a business.) The rules for forming an LLC vary by state, but here are five simple steps to get you started.
How to Convert from Sole Proprietorship to LLC
1. Choose a Unique Business Name
Check with your secretary of state’s office to ensure your business name isn’t already taken by another LLC. If it is, even if you’re currently operating under that name, you’ll need to change it when converting to an LLC. Additionally, avoid trademark infringement by running your name through this search system from the United States Patent and Trademark Office.
2. File Articles of Organization
Your secretary of state’s website will also have the requirements and paperwork necessary to file an LLC articles of organization form, a simple document with details about your business. Depending on your location, the filing fee may range from $50-$200, and will include both a one-time and an annual or biennial fee.
As part of the articles or organization, you’ll need to identify a “registered agent,” which is essentially someone available at a legal address during business hours who can send and receive legal documents. If you’re a single-member LLC, that person is you. If you have multiple members, it can be one of your partners.
If your LLC resides in Arizona, Nebraska or New York, you’ll need to take the extra step of publishing a public notice in a local newspaper.
3. Create an Operating Agreement
The operating agreement is a document outlining the rules for operating your LLC and the obligations for each owning member. This is an essential document for multiple-member LLCs that will reduce conflict among members, but it’s also useful for single-member LLCs because it overrides any default operating rules in your state.
4. Update Your Licenses, Permits and EIN
It’s especially important to be aware of the rules surrounding construction licenses and permits in your industry and area when you convert to an LLC, since you may need to reapply when your business structure changes.
Additionally, don’t forget to apply for a new Employer Identification Number (EIN) with the IRS, even if you already have one. This will be essential for filing taxes and handling payroll, opening business bank accounts and obtaining credit for your business.
5. Open a New Business Bank Account
You may currently utilize a bank account connected to your own social security number and personal assets for business transactions. But because converting from sole proprietorship to LLC forms a new legal entity that separates your personal and business assets, you’ll need to open a separate bank account for that entity. It’s important to keep a distinction between the two to protect your assets, more easily report taxes and keep your business accounting organized.
Ready to Make the Switch? Make Billd Your New Financing Partner
Once your construction business really starts gathering momentum, the benefits of shifting from sole proprietorship to LLC make the extra paperwork and fees well worth the effort. You’ll gain protection for your personal assets, professional credibility and the freedom and flexibility to add more partners to your business, and even choose how you’re taxed.
But perhaps the most overlooked benefit is the ability to take advantage of contractor financing options that just aren’t available for sole proprietors — financing that can enable you to accept more projects, tackle more ambitious projects and build your business on your own terms.
At Billd, we know the needs of construction contractors first-hand, and we know how a lack of access to working capital can stop your momentum dead in its tracks. That’s why we work with construction LLCs to secure the materials they need, when they need them, through project-based material financing. Learn more about how Billd can help grow your business.