Evolving Your Business: When to Change the Legal Structure of An Ohio Business

Running a business often involves critical moments that demand thoughtful reflection and strategic decision-making. One such moment arises when you consider changing your business’s legal structure. This decision is not merely a bureaucratic exercise but a significant step that shows the evolution of your entrepreneurial journey.

Over time, businesses undergo substantial transformations. What may have begun as a modest, one-person venture can develop into a multifaceted enterprise with multiple owners, employees, an evolving mission, and increasing complexities. As your business grows and changes, the need for a different legal structure may emerge. But how do you know when it is time to make this change? Let us delve into some of the key reasons and considerations.

Why is Selecting the Proper Business Legal Structure So Important?

Selecting the appropriate business structure from the beginning is one of the most critical decisions you will make. Before registering your business with the state, choose a structure that aligns with your values and goals. Here are several factors to consider:

1. Tax Implications: How will your chosen structure impact your tax responsibilities? Sole proprietors, partnership owners, and S corporation owners classify their business income as personal income, whereas C corporations have separate business income. This distinction can significantly influence your tax liabilities. In Ohio, this means understanding how different tax rates for personal and business incomes can affect your financial obligations.
2. Liability Protection: How can you shield your personal assets from business-related lawsuits? An LLC offers protection for your personal assets in case of legal action. While LLCs are recognized at the state level, C corporations are acknowledged federally and provide similar liability protections. Ohio Revised Code Section 1706 outlines the liability protections afforded to LLC members.
3. Administrative Requirements: What paperwork will you need to file? Each business structure comes with its own set of documentation. For instance, corporations must submit articles of incorporation and regularly file specific reports. Partnerships that want to use a fictitious name must register such a fictitious name in accordance with Ohio Revised Code Section 1329.01.
4. Organizational Structure: What hierarchical setup does your business require? In Ohio, corporations are required to have a board of directors, which must meet at least once annually as mandated by Ohio Revised Code Section 1701.61. This structure helps ensure continuity if an owner leaves or passes away, unlike other structures.
5. Registration Necessities: Why is your business structure crucial for state registration? You cannot register your business, apply for an employer identification number (EIN), or obtain necessary licenses and permits without a legal structure in place. This process is essential for compliance with Ohio state laws.
6. Fundraising Opportunities: How does your business structure affect your ability to raise capital? Sole proprietorships typically cannot issue stocks, a right mainly reserved for corporations, potentially limiting your fundraising options.
7. Potential Risks of the Wrong Choice: What are the consequences of choosing an inappropriate structure? Although you can change your business structure later, the process can be complicated and may have tax implications or even result in the unintended dissolution of your business.

Carefully considering these factors and consulting with professionals can help ensure you select the best structure for your business, supporting its growth and protecting your interests.

Evolving Your Business

So, what scenarios might prompt a change? Let us explore:

1. Adding Employees. As your business expands and you begin to hire employees, you are not just growing your team but also increasing your potential liability. This growth brings new responsibilities and risks. How can you protect yourself and your business? Transitioning from a sole proprietorship to a Limited Liability Company (LLC) or corporation can provide a crucial layer of protection. These structures create a separation between business and personal assets, ensuring that owners are not personally liable for lawsuits brought by employees.
2. Business Growth. As your business expands, you form new relationships with customers, vendors, lenders, and other stakeholders. Each relationship introduces new areas of potential liability. How do you manage these new risks while embracing growth? Switching from a sole proprietorship to an LLC or corporation offers protection for business owners against personal liability for lawsuits against the business or claims for business debts.
3. Investors and Financing. You may seek additional funding, whether through bank loans or by bringing on investors, as your business grows. How can you build trust and provide clarity to potential investors? Financial partnerships often require a more formal business structure, such as a corporation or LLC. These structures provide clear delineation of rights and responsibilities through documents like articles of incorporation or an LLC operating agreement. This clarity ensures that all parties involved understand how the arrangement will work and what their options are.
4. Optimizing Taxation. Improving the business’s tax situation is a common reason for changing entity type. How can the right structure significantly impact your tax burden? For instance, under certain circumstances, business owners might prefer a C corporation over an LLC taxed as a partnership if their personal tax rate is higher than the corporate rate. However, this choice comes with the risk of double taxation: the C corporation is taxed on its profits, and shareholders are taxed again if they receive dividends.

On the other hand, an LLC taxed as a partnership or S corporation may offer advantages such as deducting various business expenses and claiming a qualified business income (QBI) deduction of up to 20%. This deduction, also known as the Section 199A deduction, allows eligible taxpayers to deduct up to 20 percent of their QBI, plus 20 percent of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This flexibility makes it an attractive option for many business owners. An LLC can elect to be taxed as a partnership or choose a C or S corporation tax status by filing a form with the IRS. Choosing a C or S corporation tax election may also help avoid self-employment taxes. Consulting a tax advisor ensures the legal entity you choose is the most beneficial for your specific circumstances.

Typically, as small businesses grow, their operations evolve from simpler to more complex structures. In the early days, forming your home-based business as a sole proprietorship may have been sufficient. However, as you take on new owners, enter new markets, and face increased liability risks, forming an LLC or corporation becomes beneficial.

Some business owners may find benefits in simplifying their business structure. Could scaling down operations or part of a divestiture strategy be the right move for you? The fees and bookkeeping requirements of your current structure may prompt you to simplify. However, switching from a corporation to an LLC may have adverse tax consequences, and some states may not allow all types of conversions, possibly leading to unintended business dissolution.

Steps to Change Business Structures

Deciding to change your business structure involves several steps. Here’s a general outline to guide you through the process:

1. Consult Professionals: Engage with attorneys and accountants to understand the tax and legal implications of changing your business structure. In Ohio, consulting a business law attorney familiar with state-specific regulations is beneficial.
2. Register the New Entity: File the necessary paperwork with Ohio’s business registration office. This typically involves submitting articles of incorporation for a corporation or articles of organization for an LLC. Detailed information can be found on the Ohio Secretary of State’s website.
3. Create Legal Documents: Draft essential legal documents like operating agreements for an LLC or bylaws for a corporation. These documents outline the management structure and operational guidelines.
4. Appoint a Registered Agent: Designate a registered agent to handle legal documents on behalf of your business, a requirement for statutory entities in Ohio, including LLCs and corporations.
5. Update Licenses and Permits: Reapply for any business licenses and permits required under the new structure. Check with the Ohio Business Gateway for detailed guide.
6. Obtain a New EIN: Get a new Employer Identification Number (EIN) from the IRS.
7. Inform Stakeholders: Notify banks, insurance companies, vendors, customers, and employees about the structural change and update your business records accordingly.

Get The Right Counsel to Make that Change

Changing your business structure is a significant step that reflects your company’s growth and future direction. Aligning your business’s legal framework with its evolving mission and goals ensures that your business is prepared for future opportunities. Embracing these changes with foresight and proper planning is crucial.

Working with experienced business law professionals can make this transition smoother and more effective. At Rhodium Law, we are here to guide you through every step, ensuring your new business structure supports your vision and sets the stage for your continued success. Take the first step by scheduling a consultation with our team.