Since our firm receives so many calls about the benefits of incorporation, we are starting a series on Business Formation. How to decide whether to incorporate is the first installment. A future article will address seven powerful reasons to incorporate.
The right business structure can save you money and protect your personal assets
When you first started your business, all the decisions you needed to make must have seemed exciting and overwhelming – what services to provide, where to locate, whether to hire any employees, how to get customers and how much to charge them.
With so much on your mind, it was easy to overlook one of the most important business decisions an owner can make – deciding the legal form of your business. Choosing the proper business structure, such as a sole proprietorship, partnership, corporation, or limited liability company doesn’t always get decided in these early stages. But, through hard work, you have achieved some success and it is now time to think about how to protect what you have built up.
You have a choice of whether to remain a sole proprietorship (or partnership if there is more than one owner) or to incorporate your business. The decision depends on several factors, and understanding the advantages and disadvantages of each option will help you to decide which is the most appropriate for your business. If you have valuable personal assets, such as a home or car, you should protect them. One of the main reasons for incorporating a business is to protect your personal assets.
Incorporation could mean the difference between success and failure
Many entrepreneurs don’t realize that the business form they choose could be the difference between success and failure in today’s competitive marketplace. If you want to succeed, you need all the help you can get. At the top of the list of safe bets is the corporate form of business. That’s why most businesses elect to incorporate. Incorporation gives you one critical advantage: protection from liability. That means your house, car, spouse’s salary, and retirement fund are safe from creditors.
How does this work? A corporation is a separate legal entity from the person who owns it. The corporation, not the owner, enters into business deals, performs services, borrows money, and engages in other business activity. Since the corporation is involved in these business deals, you and your personal assets will, in most cases, be protected from liability if something goes wrong.
For businesses with more than one owner, incorporating can often protect you from the actions and misdeeds of your co-owners. This is unlike a partnership, where each partner is personally liable for the business-related actions of all the partners.
Advantages to incorporating
While perhaps not for everyone, incorporating offers several distinct and money-saving advantages over the other choices. Some of those advantages include tax Savings, asset protection, perpetuity, and increased credibility.
Tax Savings. Everyone is looking to save taxes. When you incorporate, there are numerous tax advantages at your disposal that are virtually impossible to accomplish with other business entities. You create a separate and distinct legal entity. Because of this, there are many transactions that you can structure between you and your corporation to save big money on taxes. For instance, if you own a building, you can rent space to your corporation and claim depreciation and other expenses. Your corporation can then deduct the rental expense. You are prohibited from doing this if you are a sole proprietor or a partner in a partnership.
Asset Protection. If you operate as a sole proprietor or partnership, there is almost unlimited personal liability for business debts or lawsuits. In other words, should you go out of business or be a defendant in a lawsuit, your personal assets such as home, vehicles, savings, etc. are at risk. This is generally NOT the case when you incorporate. When you incorporate, you are liable only up to your investment in the corporation. The limited liability feature of a corporation, while not a guarantee, is DEFINITELY one of the most attractive reasons for incorporating.
Perpetuity. When you incorporate, you create a new separate entity (the corporation). It continues despite what happens to the individual shareholders, directors, or officers. This is NOT the case with sole proprietorships, partnerships or even limited liability companies. For example, if an owner, partner, or member dies, the business AUTOMATICALLY ends or gets wrapped up in legal red tape. Corporations, on the other hand, have unlimited life.
Increased Credibility. Let’s face it. Most people feel more secure and confident dealing with a corporation as opposed to a sole proprietorship. Having INC. or CORP. after your company’s name adds a touch of professionalism and credibility to your business dealings.
Disadvantages to incorporating
There is work involved in incorporating. Since corporations are ruled by state law, documents need to be filed with the state, officers must be elected, meetings need to be held on occasion with minutes kept and copies retained. We show clients how to do all of this. Also, although a corporation can apply for a bank loan, banks sometimes require a personal guarantee from a major owner.
Sizing up the choices
No one knows better than you the circumstances of your individual business. By looking at your options carefully, you will be able to make an informed decision. Then, you can put your energy where it belongs — into running a successful business.
As always, be sure to consult with an attorney before making any important legal or financial decision. While there are many advantages and money-saving reasons to incorporate, as I’ve said before, it’s not for everybody. However, you do owe it to yourself to find out more.
There’s no question that hard work and a little luck is what it takes to BE successful. But a little knowledge, especially when it comes to setting up your business, will help you STAY successful.
Steve Katz is a Seattle business lawyer whose practice includes corporate, contract, real estate, restaurant law, and business transactions. He has business clients throughout Washington and Oregon. He can be reached at (206) 525-5500.
