When looking to grow a business, it’s important to consider both the advantages and disadvantages of the firm’s existing legal structure.

While it’s easy to create and maintain a sole proprietorship or partnership, one or two individuals become liable for any business debts and obligations, making these formations risky should the owners become unavailable, ill or die.

A corporation may be a more favorable legal structure with a perpetual existence giving the business permanence, where the corporation is held liable for the actions of the business—not the individuals who are responsible for day-to-day operations.
Most companies consider changing legal structures based on business dynamics such as attracting or accommodating opportunities to grow, reassessing liability and increasing bonding capacity.

Before making a decision, determine the impact a change will have on current operations, liability and tax obligations. Switching from a sole proprietorship or partnership to a corporation creates a separate legal entity that might result in double taxation—once when the firm makes a profit and again when dividends are paid to shareholders.

Changing from a corporation to a sole proprietorship or partnership can be challenging because it requires buy-in from each shareholder, as well as adherence to guidelines set forth by the Internal Revenue Service. This change also requires state and local entities to
be notified.

Changing legal structures may require reassessing liability coverage. For example, a firm may need to increase its general liability insurance to accommodate the cost of additional bond settlements or to defend lawsuits associated with the change in legal structure and capacity to grow. An increase in product liability insurance or commercial property insurance also may be necessary.

Additionally, the firm’s ability to generate capital may be impacted by the switch. For example, changing from a corporation to a sole proprietorship or partnership may diminish the chance to secure funding because of the risk factors associated with these formations.

In terms of daily operations, a change in structure could increase the amount of paperwork required to govern and adhere to the new legal formation. As a corporation, recordkeeping (plus the costs associated with managing the corporation) can be expensive. In addition, the amount of time required to take care of the corporation can be taxing.

Before restructuring, consider the company’s current and future critical needs. Remember, the firm’s initial legal formation may not be suitable as leaders entertain strategies to enhance and increase capacity.


Freda L. Thomas is founder of Freda Thomas Consulting and a New York State Certified Business Advisor. For more information, call (718) 938-2164, email info@consultflt.com or visit www.consultflt.com.