Many entrepreneurs start their ventures off as sole proprietorship because it is the easiest entity type to start, operate and manage from a legal and tax perspective. But, as the business grows, the sole proprietor will start to miss out on some significant advantages of operating as one of the other entity types.

From a liability perspective, the sole proprietor faces ever-increasing exposure to personal liability as the business grows. Without a corporate veil of some sort to shield him or her, the entrepreneur is faced with unlimited personal liability if things go wrong.

Another negative implication of continued operations as a sole proprietor is the loss of some significant tax savings. For example, as a sole proprietor, the business owner is taxed fully on all profits from the business. If the company was operated as an S-corporation, the owner would not be taxed on any distributions from the business, rather he or she would only be taxed on a “reasonable” salary drawn from the business.

With these and other considerations in mind, growing businesses making a shift from the sole proprietorship form to another type of business entity need to take the following steps:

1. Formation of the entity.

• All of the documentation required by the state to create the entity must be filed at the time of formation. This usually includes a certificate of formation, articles of incorporation and an initial annual report.
• Internal operating documents, including shareholder agreements, bylaws, and partnership agreements, should be drafted and entered into by the relevant people.

2. Business licenses.

• Federal Employer Identification Number. If the sole proprietorship operated under the owner’s personal social security number (please DON’T do this), and the new company will be hiring employees, a new federal EIN must be obtained. If the sole proprietorship had its own federal EIN, there is no need to obtain a new number, but notice must be given to the IRS of the change in the name when the next sole proprietorship tax return is filed.
• State business licenses. Most states require a new state business license application to be filed, because, for state law purposes, the business is a new legal entity.
• City business licenses. Most cities also require a new license for the new entity.
• Other business licenses. Don’t forget to transfer other miscellaneous licenses that apply to your business. These may include, for example, liquor licenses, contractor’s licenses, professional licenses (accounting, architecture, real estate broker, medical), and special state or local government permits.

3. Contractual Obligations.

• All loan obligations, real or personal property leases, vendor agreements, and other contractual commitments, between the sole proprietorship and third parties must be assigned to the new entity. This is usually accomplished by a document signed by both parties.
• Bank accounts. The institution with which the business does its banking must be notified that the company is changing to a different entity type. Most banks require some sort of documentation from the state showing that the change has already occurred.
• Insurance. Make sure to contact the company’s insurance agent to ensure that all policies reflect a change in entity and to determine if there is a need to drop or add any coverage.

4. Notice to clients and creditors.

• I recommend that the business owner send out an announcement to clients about the change in business entity and name (if applicable). Not only is it a good way to put your customers and clients on notice for liability purposes, but it is good from a marketing perspective to touch base with customers to let them know you are still out there and ready to provide products or services.
• Creditors should also receive notification of the shift in entity form. You should also ask if they require any specific paperwork to shift future business liabilities to the new entity.

There is no one, magical entity that works for everyone, but most experts agree that businesses should move away from the sole proprietorship form when they start to become successful and become more established in the marketplace.

So, celebrate your success! Then, go see your personal advisor.