My friend recently asked if he should incorporate your business for his business. I fairly quickly told him no, that he doesn’t need to incorporate his business. However, the reason for this response might not be so clear to some. Hence this article.
Please remember that this is my personal commentary on whether or not to incorporate. If you’re getting serious about your business, I recommend you read a few books on the topic and possibly even talk to an attorney or family business consultant. (Just about every “guide to starting a business” will have a section explaining the different business structures.) Make sure to do adequate research on your own before diving into such an endeavor. Creating a profitable business online or off is an extreme process. It’s not for the faint of heart.
Before we move on, let’s review the various business structures:
1. Sole ProprietorshipAt its most basic, anyone that performs a service is automatically considered a sole proprietorship unless they specifically set up another business structure. Generally, a sole proprietorship consists of a single person or a few employees. However, there is absolutely no limit on the size of your sole proprietorship. Technically, even a company the size of Wal-Mart could be a sole proprietorship, but it usually makes sense for larger businesses to use a different business structure.
2. PartnershipWhen two people start a for-profit business, it’s considered a partnership. There’s usually, *and should be*, a contract covering the distribution of revenue, as well as what would happen if one or both of the partners chose to leave the business. In most states, disputes are handled under the Uniform Partnership Act (UPA). A partnership is basically a sole proprietorship, but with 2 or more people. If you go into business with a partner, no matter how utopian the initial arrangement is, you must make sure to write up a detailed partnership agreement. You’ll appreciate it if things ever turn sour.
3. CorporationWhen you form a corporation, you’re actually creating a new legal entity. This new entity can do just about anything a person can. It can get credit, make a profit, and get sued. To incorporate, you need to complete several incorporation documents specific to the State of incorporation. When the corporation is created, shares of stock are issued to shareholders. These shareholders trade something of value, such as money or expertise, for their shares. These shares are created regardless of whether the corporation is public or private. If your corporation is private, all of the shares could be owned by yourself, or maybe by some close friends and family. Once your corporation goes public, anyone may buy shares of your company at the going price.Corporations are also divided into C-Corporations, Subchapter S Corporations, and Limited Liability Corporations (LLC). Large companies generally form C-Corporations, while smaller companies usually choose an S Corporation or LLC. There’s less paperwork and regulation on the latter two as long as they follow certain guidelines.
Ok, so why shouldn’t I form a corporation?
There are several myths out there as reasons one should incorporate a business. The top 2 are tax savings and personal liability.Ok, now to disspell those incorporation myths:
1. Tax Savings
I’ve read so many times on the Internet that I should incorporate for the tax benefits. They usually go something like this: “If you incorporate, you can write off business expenses, business meals, and even a portion of your mortgage!”However, you can do all of these as a sole proprietor! I have owned my own business in one form or another for the past 10 years. Every year, I was able to deduct business expenses. (Always consult a tax attorney. This is not advice. It’s only my opinion.) I wrote off equipment, meals, travel expenses, part of my mortgage, part of my utility bills, even some supplies to spruce up my office. The key is that a sole proprietorship is a business. As a business you can deduct your business expenses from your income. (Again, I’m not a tax expert. This is just my experience.)I did form an LLC a few years ago and the only difference was that I paid a bunch of money to fill out a bunch of forms and follow a bunch of rules. Then, at tax time, I got a penalty because I didn’t dot all of the i’s and cross all of the t’s. Thank you, but I’ll choose a sole proprietorship every time.
2. Personal Liability
First, I will admit that this is true. Technically, a corporation is a separate entity, and if it is sued, your personal assets cannot be taken. If you are running an honest business and someone slips when leaving your house after a meeting, this business structure should stop them from being able to take your house. (Again, this is not legal advice. This is just how I think it should work.) I’d say an exception to this entire post would be if you are running a brick and mortar business. You could absolutely have a slip and fall situation and you’ll be glad to have this layer of protection. On the other hand, if you’re starting a wholesale business, or other venture that is almost entirely online, you’ll have a tough time convincing me to incorporate.
HOWEVER…This does not mean you are exempt from all responsibility. If you personally are negligent or dishonest in your business dealings, a judge will come after your personal assets every time. Many judges are looking to determine why you formed your corporation. If they find that it was so you could rack up huge debt and/or scam your customers, expect the corporation to be sued, but you can bet you’ll be named as a co-defendant. Yep, that means YOU are personally responsible for everything.
In closing, I want to say that I always wanted to start a corporation. I thought that creating a corporation made my business legitimate, but I was fooling myself. Sure, it puts the business on paper, but the only things that really matter are how you are helping your customers and whether or not you’re turning a profit. You’ll need to decide whether a corporation is necessary for your situation, and I wish you good luck in your endeavor.
A good resource for additional information on this topic and many others is my business advisor, Rich Snebold.