Five Reasons to IncorporateBy Nina Kaufman, Esq.
If you’re in any of these situations, then it might be the right time to protect your personal assets.
So, you’re ready to start your own business. But you’re caught up in the creative excitement and don’t want to deal with pesky management issues and decisions like incorporation. Must you form a business entity right out of the starting gate? Or can it wait for a later time?
In short, when’s the right time to incorporate?
- When you have personal assets to protect. Entrepreneurship is about taking a risk in order to make a profit. What you have to lose depends on what you own at the time you start your business. Do you own your home? A car? Do you have substantial savings in your bank account or a collection of art deco jewelry? All of your personal assets are on the line if you’re caught in a lawsuit and don’t have a business entity to shield you. Imagine a computer consultant whose network configuration unintentionally crashes the server or a graphic designer whose logo unintentionally infringes someone else’s trademark. Either of these scenarios could get you sued.
- When you bring on partners or hire employees. Business growth is an exciting phase, but it needs to be tempered with risk management. That’s what Ann Siegle of Tria Marketing & Design faced as she grew two of her businesses. Early in her serial entrepreneurship, when she added employees to her home-based design firm, she made the move from sole proprietorship to S Corp, which offers some tax benefits a regular corporation doesn’t. Upon going into a second business with partners, Siegle sought the structure and liability protection of a limited liability company.
- When you begin to sell a product or own real estate in your business. Some entrepreneurs may be able to manage their liabilities with insurance protection. But certain kinds of liabilities can exceed the limits of the insurance policy. This can occur if your business involves selling a product (Pokémon plush toys, anyone? Check personal injury law firm Weitz & Luxembourg’s list of recent toy recalls). Where will creditors look if you don’t have a business entity? That’s right: your personal pockets. Same with owning real estate, which can be a big-ticket liability item. That’s why Siegle chose to form an LLC when she became the co-owner of a building.
- When you want to reach a Fortune 5000 target market. Larger companies (not just Fortune 5000) like to use independent contractors because they can avoid paying Social Security and Medicare taxes. If a consulting assignment stretches for long periods of time (some can go for months or even years), the consultant starts to look dangerously like an employee. (See related story: Your Contractor Might Be an Employee.) As a result, more companies will only do business with consultants who operate their businesses as corporations or LLCs. Does it make sense to be passed over for a $50,000 assignment because you wouldn’t spend $500 on getting incorporated?
- When you seek external financing. Don’t expect to get investment capital without a formal business entity in place. Investors want the structure and limited liability protection that a business entity provides, along with a clearly defined exit strategy (which your shareholders’ or operating agreement will address). Forming a business entity also sends the signal that you expect your business to have staying power, because the business entity can outlive you.
While both corporations and LLCs can work, a number of investors — especially venture capitalists — prefer corporations because your stock can be traded on stock exchanges .Ecobold founder Steffany Boldrini learned this lesson when her company, which spotlights green products and entrepreneurs, was accepted to a Silicon Valley startup incubator about a year after launching. Although the company was originally formed as an LLC, Ecobold needed to make the switch to a corporation as one of the incubator’s requirements.
If you’re encountering any of these important “life stage” issues in your business, get an attorney and an accountant on board so you can choose the business entity that’s right for you.
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