When Should a Small Business Change Its Legal Structure?

Last updated on June 1, 2023

woman packing boxes for business

Businesses grow, evolve and change. When this happens, it might make commercial sense to change the legal structure of your business. In many cases, small businesses change from a simple business structure such as a sole proprietor or simple partnership to a more complicated one such as a Limited Liability Company (LLC) or corporation.

This article will cover:

What Business Structures Do Small Businesses Typically Have?

There are many types of business structures that small businesses can have. Some common business structures a small business may have include a sole proprietorship and a partnership. A sole proprietorship is a business owned and operated by a single individual, whereas a partnership is owned and operated by two or more individuals.

When Should I Consider Changing Business Structures?

As a small business owner, you might want to consider changing business structures when you are taking on new owners or investors, especially when you want to expand your business operations. For instance, changing your business structure from a Private Limited Company (Pte Ltd) to a Public Limited Company (Ltd) allows the company to issue shares to the public and raise additional capital for future expansion or investment opportunities.

You may also consider changing your business structure if you wish to benefit from the legal protections and potential tax options available to some of the more complex structures. 

Benefits of Changing Business Structures

Tax benefits 

Different business structures have different tax implications. Sole proprietors, partnerships and certain types of corporations classify their business income as their personal assets. Other types of corporations will separate business income from your personal income. As different tax rates for business and personal incomes apply, business structure choice can significantly impact your payable tax.

For instance, if you choose to operate a sole proprietorship, you would have to report all of the business’ income and expenses on your personal tax return. However, this may not be ideal for you because reporting the above will mean that you will be paying self-employment taxes on all of your earnings which can be financially draining.

On the other hand, having a business structure such as an LLC or a corporation may allow you (the business owner) to have tax exemptions or reductions like the Partial Tax Exemption or the Corporate Income Tax Exemption: 

  • Partial Tax Exemption: From 2020 onwards, all qualifying companies will benefit from (1) a 75% on the first $10,000 of normal chargeable income and (2) an additional 50% exempt on the next $190,000 of normal chargeable income.
  • Corporate Income Tax Exemption: All companies incorporated in Singapore will benefit from a Corporate Income Tax rebate up to the value of $15,000 per annum.

Limited liability 

Limited liability protects business owners’ personal assets from lawsuits and other legal actions that may be taken against the business. As sole proprietors have unlimited liability, if a business is structured as a sole proprietorship, the owners’ personal assets, such as their home or car, may be at risk if the business is sued or cannot pay its debts.

Changing the legal structure of a company can be especially beneficial for small business owners, as it can help protect their personal assets and reduce their risk in the event of a lawsuit or other legal action. This means that these small businesses that may not have the financial resources to absorb significant legal or financial liabilities are now protected by limited liability – this also helps to mitigate the risks associated with owning and operating a business, providing owners with a greater peace of mind and allowing them to focus on growing their business.

I am a Business Owner Thinking of Changing Business Structures. What Factors Come Into Play?

If you are considering changing business structures, several factors come into play:

Type of business 

The type of business that you are running can have a significant impact on the best business structure to choose. 

Small-scale businesses

Some businesses like home-based bakeries may be better suited to a partnership or sole proprietorship when the business is of a smaller scale and requires less managerial assistance. Instead, the owner has complete control over all aspects of the business, such as baking and decorating the cakes, packaging, and delivery services.

Businesses looking to expand

An LLC in Singapore has access to various government incentives, such as tax exemptions and grants for business expansion. This can be especially useful if you are planning to expand your restaurant business to multiple locations or offer new services.

Liability concerns 

The level of liability protection you may want is another key consideration.

For example, an owner of a small restaurant business that is a sole proprietorship may be held responsible for certain debts that occur during their business. Hence, the owner may want to consider a business structure that provides greater protection against personal liability, such as an LLC.

Limited liability is a feature of an LLC, because the law limits the liability of a corporation by recognising it as a separate legal entity from its owners or shareholders. This means that the corporation has its own legal personality and can enter into contracts, own property, sue or be sued, and carry out other activities in its own name as a corporation. The greater protection, as mentioned earlier, comes into play because now, the owner of the LLC or corporation will not be directly sued or held personally liable when legal action is taken against the owner.

However, there are limits to this protection. For example, if the owners or shareholders have engaged in illegal financial activities such as embezzlement or money laundering, the court may choose to disregard the separate legal personality and hold them personally responsible for the corporation’s debts.

When Should I Not Change My Business Structure?

When it impacts customer relationships and loyalty 

Customer profile is an important consideration. Depending on the nature of the business and its customer base, changing the business structure could have a significant impact on customer relationships and loyalty.

An example is if your business has established a strong reputation as a sole proprietorship, changing to an LLC could create confusion or concern among customers because they may perceive the change as a shift in ownership or direction. As such, they may need to be informed of the change in business structure and any resulting changes in the business’s name or legal status. This can be done through communication channels such as a website, social media, or even direct communication with customers.

Similarly, if your business is known for its personal touch and direct relationship with customers (i.e. a home-based bakery that builds its business around meeting customers’ needs), changing to a more formal business structure could undermine that personal connection. Such a formal business structure could create a perception of distance between your business and its customers, where customers may feel that your business is less approachable and less personal, which can undermine the connection that they feel with your business.

Different Legal Structures For Businesses in Singapore

In Singapore’s context, there are different legal structures for businesses. Some common business entity types include sole proprietorships, partnerships, limited liability companies and corporations.

Sole proprietorship

A sole proprietorship is the simplest business entity. If you are a sole proprietor, you are responsible for all a company’s profits and liabilities. A sole proprietorship is ideal if you are just setting up your business and wish to run it from home without a physical storefront. However, this may become problematic as there is no separation between your personal and professional assets.

For example, suppose you own a home bakery business with a sole proprietorship structure. You use your personal equipment for the business and do not establish a separate bank account for your business. One day, you are unfortunately sued by a client for damages caused due to a food poisoning incident. Since there is no legal separation between personal and business assets, your personal assets, including your house and baking equipment, may be at risk of being seized to satisfy any damages awarded to the client. However, this will only occur if you are unable to pay up the amount of damages monetarily.

Partnership

A partnership is owned by two or more individuals. Usually, there is a general partnership (i.e. where assets and liabilities are shared equally) and a limited partnership (where only one partner has control of operations and the other person contributes to and receives part of the profits).

Company

A limited liability company (LLC) is a hybrid structure that allows owners, partners or shareholders to separate their personal liabilities while enjoying a partnership’s tax and flexibility benefits. In an LLC, these partners, and shareholders are shielded from personal liability for the business’s liabilities.

For a more detailed overview, please refer to our other article on the different legal structures of business

How Would the Business Structure Affect My Liability?

Changing the legal structure would affect the liability of a business owner depending on the type of structure you are looking into.

If you are the owner of a sole proprietorship, you would be personally liable for all debts and legal issues related to your business. This means that if your business is sued or cannot pay its debts, your personal assets, such as your home or car, may be at risk.

On the other hand, if you are in a partnership, all partners share liability for the business, and each partner is personally responsible for the actions of the other partners. This means that if one partner engages in illegal or unethical activities such as embezzlement or money laundering, all partners can be held liable. 

For a more detailed discussion, refer to these articles on limited liability companies, exempt private company, company limited by guarantee.

Will There be Any Implications on My Tax Obligations?

Different legal structures are subject to different tax rules, so it is important for business owners to consider the tax implications when deciding whether to change the legal structure of their business.

  • Sole proprietorship: It is a pass-through entity, which means that the business owner reports all business income and expenses on their personal tax return.
  • Corporation: It is a separate legal entity that is subject to its own tax obligations. Corporations are taxed on their profits at the corporate tax rate, and shareholders may also be subject to their own tax obligations. Corporations are taxed on their profits at the corporate tax rate, and shareholders may also be subject to taxes on any dividends they receive.
  • LLC: It can be taxed as a pass-through entity or as a corporation, depending on the number of members and the election made by the members.

Will I Lose Control of My Business If I Incorporate or Change Structures?

The short answer is no. However, it is important to understand that different legal structures come with different rules and regulations and this will affect how your business is run and who has the decision-making authority.

If you are a small business owner looking to incorporate your business, you may need to appoint a board of directors. You will still be overseeing the management of the company, and are responsible for making strategic decisions and appointing key decision-makers to manage day-to-day operations. A common concern for small business owners is losing ‘ownership’ at the mercy of shareholders and other board directors.

However, this concern of losing ‘ownership’ over key decisions can be addressed if you still maintain a significant degree of control over the company by serving as a director on the board, or by retaining a majority stake in the company. For instance, creating a board of directors with trusted advisors can help a small business owner preserve control by providing guidance and support without giving up ownership. The board can offer expertise and feedback while allowing the owner to retain ultimate decision-making power.

There are many considerations that come into play when deciding whether and when to change business structures. Such considerations include:

  • Whether there are benefits to changing business structures
  • Whether there are disadvantages to changing business structures
  • How the business structure of my business would affect my liability in terms of debts and legal obligations
  • Whether there would be any tax implications on my tax obligations

If you think that there is a change in your business needs, such as decreasing personal liability risk, increasing potential growth in the business, and decreasing tax liability, then perhaps a business structure change would be desirable.

If you need legal advice on how best to approach changing the legal structure of your business, please consult a corporate lawyer for advice. A corporate lawyer can help a small business owner in this regard by providing guidance on the legal requirements and implications of different business structures, including the pros and cons of each option, which may be important for a small business owner. 

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