Passing your family business to the next generation

When you started your family business, you likely started it as a sole proprietorship. But that doesn’t mean you worked at it and grew it all by yourself. You probably hired employees, expanded the business and maybe even brought in your children to have them help out.

The years pass. Your business thrives and becomes a local fixture—one of the many family-owned small businesses driving Colorado’s economy. You love the work, but there may come a point that you need to step away from it. If you plan to leave your business to your children, you may want to convert it to a limited liability company (LLC) at the same time.

What are the advantages of an LLC?

An LLC is a relatively new and exceedingly flexible business structure that allows owners—even a single owner—to gain some valuable legal separation from the business. This structure comes with several advantages over sole proprietorship:

• Legal protections. As noted above, an LLC minimizes the personal risks you assume for running the business. In some cases, this may allow owners to take risks they wouldn’t have dared had they been personally liable—such as they would be with a sole proprietorship.
• Tax flexibility. You can reduce your self-employment tax by choosing to have your LLC taxed like a corporation.
• Shared responsibilities. When you form an LLC, you can leave it in the hands of a single decision-maker, or you can outline various executive roles and the responsibilities of each. If you have multiple children interested in your business, this step may help avoid some potential conflicts.
• Longevity. If your business is a sole proprietorship, the government basically sees you and your business as the same legal entity. This means that if you stop being a part of the business, the business ends. This is true even if you pass it to your children; you cannot really hand them the business—just the assets. But with an LLC, you can write guidelines for transferring ownership (“member interest”) into your operating agreement.

How do you convert your business to an LLC?

Here’s the tricky part. Much as if you wanted to sell your sole proprietorship, you cannot really hand everything over in one fell swoop.

Instead, when you remove yourself from your sole proprietorship or convert it to an LLC, the change requires a new Employer ID Number (EIN). The LLC will also need its own bank account, separate from the one you had used for your sole proprietorship. Finally, you’ll need to file your Articles of Organization with the state and create your LLC’s operating agreement. Perhaps you won’t even cut yourself out entirely—if you and your children agree, you can write yourself into an advisory role!

Leaving the business poised for success

When you decide your children are ready to take on the family business and you’re ready to step away from it, it’s time to think about how the business might change for the future. Even if they agree with the way you’ve done things, your children will need to adapt to meet future challenges. Converting your business to an LLC might offer them the legal protection and organizational clarity they need to tackle those challenges and keep the business strong for generations to follow.