Not sure if you need to form an official business structure for your company now or just wait a bit until business picks up and you are ready to expand?
Below are the top reasons why business owners take the step to incorporate or form an LLC. See if any apply to you.
Reasons to Incorporate
1. Separate Personal From Business
When you’re operating your business as a sole proprietorship or partnership, there’s no separation between the business and the owner. In this case, the owners are the business. They’re responsible for signing any contracts, and taking out any loans or lines of credit on a personal level.
In addition, if there’s any kind of issue with the business (i.e. a customer sues or creditors seek action), the owners are personally liable. That means personal assets and savings can be at risk.
One important reason for incorporating a company or forming an LLC is to protect the owners/stockholders against personal liability. These official business structures put a wall between the owner and the business. As long as the company complies with all the necessary corporate formalities, then creditors/court judgments generally cannot reach an owner’s personal assets to satisfy the company’s liabilities.
For this reason, people usually want to incorporate/form an LLC before launching their product or service, since the risk of liability increases once you add in customers, users or clients.
2. Prevent Misunderstandings Among Founders/Partners
When a business has more than one founder, there’s always a chance of an argument over how equity should be split – no matter how close the owners may be.
Incorporating a company and issuing stock to the founders will prevent misunderstandings among equity splits. Even if you choose to form an LLC and not issue stock, you will still have formal paperwork in place that outlines how ownership is split.
3. Allows You to Issue Stock Options
Many entrepreneurs choose to compensate third parties (i.e. employees, vendors or contractors) by granting stock options or offering the opportunity to purchase equity at a low price. This is particularly attractive at the beginning of a business when cash is tight.
It is possible to put together a pre-incorporation agreement stating that someone will get equity (stock) upon incorporation, but it’s a lot simpler to incorporate the company first, and then make these kind of offers.
4. Allows You to Get Funding and Establish Business Credit
If a third party investor wants to invest in your business, there obviously needs to be some kind of entity set up to accept the investment. Venture capitalists and other investors often prefer to work with corporations, since they allow for different classes of stock.
If you’re not looking for VC or angel funding, you still may benefit from a formal business structure. That’s because owners in partnerships and sole proprietorships need to sign contracts in their own name. That means you’ll need to rely on your personal credit and assets to take out a loan or ask for a line of credit.
But once you form an LLC or corporation, the business itself begins its own credit profile.
5. Gives Your Business More Credibility
You may find your sales grow after forming an LLC or incorporating, as adding an LLC or Inc. after your company name boosts your credibility in the eyes of some customers.
In some industries, a formal business structure is required to win certain contracts. Some larger companies are more comfortable hiring a business, rather than a sole proprietor to do the work.
6. Adds a Layer of Privacy
When you incorporate or form an LLC, there’s an added layer of privacy. In many cases, the registered agent of your corporation goes on record, and not your home or business address.
7. Offers Potential Tax Benefits
In some cases, corporate tax rates are lower than individual tax rates. Corporations and LLCs often qualify for additional tax benefits and deductions that aren’t available to individuals.
Many sole proprietors choose to incorporate as a way to lower what they owe in self-employment (SE) taxes. Of course, specific circumstances vary, and you should consult with a CPA or tax advisor about your own particular tax situation.
Incorporating or forming an LLC is a big step, but offers some key benefits, even for the small, solo or family-owned business. Having an Inc. or LLC after your company name isn’t just for big business.
Just keep in mind that once you decide to create a formal business structure, you’ll have to keep up with ongoing filing obligations. But it might be one of the smartest steps you take for your business and personal finances.
Incorporate Photo via Shutterstock
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Aira Bongco
One of the best things about incorporating a business is that you can get some funding upon startup. You’ll also lessen the confusion with your personal belongings so that it will not get in the way in case your business fails. Yes. It adds credibility but that is just a bonus.
Kip Marlow
Nellie, a good article. Love to have a radio show on these.
The difference between LLC & private ownership is properly distinguished, hope it helps many to choose the correct way for starting a business, Since LLC label is far more superior in terms of credibility & privacy, but one needs to be thoroughly versed with business requirement basis on which they need choose the best.
Aira Bongco
I agree with that Steve. New business owners really need to get more familiar with all these terms before they incorporate their business. It can get very confusing at times.
A good thing when incorporating is having that corporate veil.
If I’m starting a new company I’ll go with an S Corp to start off and see where it goes from there.
Johnbob
When I formed my LLC my attorney informed me that
even though the business assets Would be formally separated
from personal assets, I as an individual and the company
could still easily be sued
If I were to say, wreck the company vehicle killing somebody
and was solely at fault. Etc. (heaven forbid)
corporate veil only goes so far for us very small
Company’s where the owner does most the work and duties.