Why Forming a Business Entity is Worth the Expense

By Nina Kaufman, Esq.

Why bother? Yes, some companies can cover many of their potential business risks with insurance. But in my opinion, if you intend to go into business, you should intend to form a separate entity. Create a plan and a budget that encompasses those costs. The risks to your personal assets and to your business growth far outweigh any advantages of sole proprietorship. Read on to find out why!

Risk #1: You’re facing the world naked.

Doing business as a sole proprietor is like going into battle without armor. Even if you have insurance, it won’t protect you against certain kinds of “weapons” – such as lawsuits that exceed the policy amounts, or aren’t covered altogether. As a sole proprietor, you place all of your personal assets at risk. One freak lawsuit, and you could lose it all: your home, bank accounts, savings, car, jewelry. Think of the computer consultant whose network configuration inadvertently crashed the server; the graphic designer whose logo creation may have infringed on someone else’s; independent sales rep accused of misusing a company contact list. I can’t tell you what the odds are of being sued, but I’d sleep better at night knowing that I had a layer of protection over me nonetheless.

Risk #2: Bankruptcy records last a long, long time.

If your industry changes, or clients dry up, or you’re slapped with a judgment you can’t pay, you may be facing the need to declare bankruptcy. Corporations and limited liability companies have the option to go through a bankruptcy proceeding without having to include the business owners. Sole proprietorships don’t have that option. Although technically, it’s a fresh start from old debt, bankruptcy impairs your ability to get credit cards and other needed financing for future use. Plus, a bankruptcy can stay on your credit record for 10 years . . . and even longer! How fresh a start is that, really?

Risk #3: Larger companies may not want to work with you.

Are you looking for consulting work with larger companies? If so, operating as a sole proprietor may disqualify you from plum projects. Why? Larger companies 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 years!), you start to look dangerously like an employee. As a result, more and 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?

Risk #4: You limit your opportunity to expand.

Tired of doing it all yourself? If you are thinking of bringing on a business partner, you’re out of luck. By definition, you can’t have a partner in a sole proprietorship. You have to form a different business entity. Did you know that in many states, you can be the sole owner of a corporation or LLC (confirm this with a local attorney)? If you had formed one already, you’d have more options and better control over who joins you and on what terms. Give some thought to the future of your business. Your form should reflect not only what’s convenient for today, but also what helps you grow for tomorrow.

Risk #5: You risk falling into “scarcity thinking”.

Every time you say, “no, I won’t spend the money on that,” what kind of choice are you making? Do your reasons truly support the health and growth of your business? Or do they reflect your fears and insecurities. While it makes good business sense to keep your spending within budget, have you also planned for investment in your business?

Forming a corporation or LLC will probably be one of the first important investments you make in your company. If you’re deciding not to do it, look at the reasons why. The real reasons. Are you afraid of building a company that outgrows you (need for control)? Are you worried about starting your business with an entity whose minutiae you don’t fully understand (don’t want to need help)? Are you concerned about the ongoing taxes and costs of the entity (“I can’t afford it”)? All of these might be a reflection of scarcity thinking – “there aren’t enough resources; not enough money; I’m not enough to handle it all”. That attitude will not serve you.

Forming a separate business entity is a crucial first step in the life and growth of most entrepreneurs. Don’t waste you’re time worrying about the worst that can happen. Find a small business attorney and accountant to help you make the decision, and then spend your time focused on the best that will happen for you!

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