How to convert your sole proprietorship into a limited liability company?

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Michał BOBROWSKI
Corporate Advisory Assistant at RSM Poland
 

Many entrepreneurs who embark on their journey towards running their own business, opt for the simplest business structure, namely a sole proprietorship. The reason behind it is that is it not complicated and involves low start-up expenses, relatively few formalities, low costs and a quick registration process. However, as your business grows, other forms of running it may prove better for you.

What business structure can your sole proprietorship be converted to?

According to the provisions of the Code of Commercial Partnerships, a sole proprietorship can only be turned into a capital company, i.e. either a limited liability company, a joint stock company or a simple joint stock company. A limited liability company is definitely the most popular option here.

Changing from sole proprietorship to LLC is the right move as it grants you limited liability, therefore the business risk is reduced. In certain cases, in particular due to changes introduced by the New Deal, you can pay less in tax.

What the conversion is all about?

Changing your sole proprietorship to LLC can be presented as a change of business structure. The new entity thus continues the activity of a sole proprietor, in particular by becoming a party to contracts originally concluded by the sole proprietor.

Is it a good idea to move from sole proprietor to LLC?

There are many factors to consider when assessing your situation. Therefore, even though conversion is usually the right move, it is always worth consulting your individual case with a professional advisor. What advantages can such a professional point out?

Limited liability

A natural person who is a sole proprietor is responsible for all business liabilities (e.g. company debts) with all their assets, including personal assets. What is more, in the absence of appropriate marriage contracts, the entrepreneur’s spouse may be liable for company debts.

Shareholders in a limited liability company are not responsible for business liabilities. In contrast to a sole proprietorship, the risk in the event of failure is generally limited to the assets brought into the company (or any financing provided, e.g. loans).

In summary, a limited liability company provides greater protection of the entrepreneur’s assets.

Greater financial opportunities

Entrepreneurs who have converted their sole proprietorship into a limited liability company gain new ways of financing their investments. First of all, they can create shares in the company, which the new shareholder (investor) will take up in exchange for contributing certain funds to the company. Shares in the company may also be sold, as this provides necessary funding. It directly boosts your business growth opportunities.

What is more, sometimes sole proprietors cannot apply for certain grants. This is due to the criterion of the legal form of your business. Thus, switching to LLC offers greater options of getting funds for running your business.

What formalities do you have to complete to turn your sole proprietorship into LLC?

As a first step, you have to prepare a business conversion plan. This document must be created in the form of a notarial deed with the following attachments:

• draft business conversion statement,
• draft memorandum of association of LLC,
• valuation of the assets of the entrepreneur who is switching to LLC (both assets and liabilities),
• financial statements for the purposes of business conversion.

As a next step, a statutory auditor shall examine the conversion plan. The registration court appoints the statutory auditor upon request of the entrepreneur who is switching to LLC.

Once the auditor has approved the business conversion plan, the entrepreneur should file a business conversion statement. This statement is made in the form of a notarial deed, listing among others, the company type and the amount of its share capital (not less than PLN 5,000).

The next step is to conclude articles of association of a limited liability company in the form of a notarial deed and appoint members of its bodies. The management board is an obligatory body of such a new company. It may consist of one person and the entrepreneur who is switching to LLC may be a member. The articles of association shall be concluded in the form of a notarial deed. What is more, members of the management board must be appointed; however, nothing prevents the board from being composed of one person only.

The last step of the business conversion procedure is to file a request to have the company entered to the National Court Register and have the sole proprietor removed from the Central Register and Information on Economic Activity.

Please remember: apart from the necessary steps mentioned above, you may be required to do more. For example, if a sole proprietor is the owner of real estate, the update of the land and mortgage registers shall be carried out separately, in a separate request submitted to the competent court keeping the land and mortgage register for this real estate.

Essential implications of switching from sole proprietorship to LLC

Converting a sole proprietorship to LLC results in a number of legal consequences, namely:

• An entrepreneur who moves from sole proprietorship to LLC becomes a shareholder of LLC.
• The business name may stay the same, with the company type added. If the business name is changed, the converted company is obliged to provide the old business name in brackets next to the new one, with the note “formerly”, for at least a year after the conversion.
• Rights and obligations: the company is entitled to all the rights and obligations of the entrepreneur who switched to LLC (the company directly continues the business of the sole proprietor).
• Liability: the entrepreneur being a natural person shall be liable together with the converted company for any liabilities resulting from the business they were running earlier. This applies to liabilities incurred before the business conversion date, for three years from the conversion date
• Tax implications:  please remember to submit relevant notifications to the tax office (e.g. VAT notifications).

Is it a good idea to convert your sole proprietorship into LLC?

There is no universal answer to this question. Much depends on the situation and needs of a given entrepreneur.

In our experience, if an entrepreneur is pursuing business growth, or their business has already significantly expanded, switching to LLC is the right move. The entrepreneur, in addition to reducing the financial liability for their actions, gains more fundraising opportunities to finance their capital. Doing business as a limited liability company may also be good for the image of the company, and in certain cases it is even a requirement imposed by investors or contractors.

At first sight, the conversion procedure may seem complicated and costly. Despite this, it is often less time-consuming and less complicated than starting a new company and, for example, contributing the business of the sole proprietor to it in kind.

Moreover, switching to LLC allows the continuity of the rights and obligations of the converted company to be maintained. This means, among others, that it will not be necessary to individually transfer contracts concluded so far by the sole proprietor.

In summary, if you are a sole proprietor and you want your business to grow, turning it into LLC may be a good idea for you.

Given the rapidly changing regulations and the maze of procedures, it is best to consult our team of experienced advisors to find the best option for you.