People starting businesses in California often form sole proprietorships. This is the simplest business structure possible, and many entrepreneurs default to sole proprietorships until their companies start generating revenue.
Once a business becomes profitable, owners need to consider their exposure and take steps to protect themselves. Frequently, that process requires converting the sole proprietorship to a limited liability company (LLC). LLCs offer tax benefits for business owners and also mitigate the liability of the business owner. Following the steps below can help those running small businesses in California protect themselves and their growing companies.
Step one: Register the LLC
In some cases, switching from a sole proprietorship to an LLC may require a name change. Validating that the LLC name conforms to state rules and includes either “LLC” or “limited liability company” in the name is a key step. Once the paperwork for the LLC is complete, the business owner or their attorney submits the articles of organization via Form LLC-1 to the California Secretary of State and pays a fee. They must also name an individual to act as the registered agent who receives all legal paperwork for the company.
Step two: Submit a Statement of Information
Once the state has received LLC registration paperwork, the next step is to submit Form LLC-12, also known as a Statement of Information, to the government. The LLC must pay a separate filing fee for this document.
Step three: Create an operating agreement
Even in scenarios involving sole members without partners or investors, LLCs must have a written operating agreement. The document outlines operational standards and guidelines for financial matters. Proof of an operating agreement is necessary to open a business checking account in California.
Step four: Address taxes and bank accounts
Converting a sole proprietorship to an LLC requires a new employer identification number (EIN) from the IRS. Once the company has a new EIN, it is then possible to establish a new bank account in the name of the LLC. The company also needs to retain funds to cover state franchise taxes, which may be as low as $800. Higher revenue may mean higher franchise taxes.
Step five: Update asset ownership and contracts
Any official paperwork in the name of the sole proprietorship may require new documents in the name of the LLC. A formal transfer of key resources, such as vehicles, may be necessary. Outside parties may need to revise existing contracts or execute new agreements using the name of the LLC instead of the sole proprietorship. Similarly, any business licenses or permits require updates to ensure they are now under the name of the LLC instead of the sole proprietorship.
Managing all of those steps while simultaneously running a successful business can be incredibly challenging. Business leaders hoping to establish an LLC after a sole proprietorship proved successful might benefit from retaining a lawyer to oversee and manage much of the business conversion process accordingly.