Incorporating can have powerful advantages for those who own a small business or who work as a freelancer or contractor.
If you’re a business owner — or thinking of becoming one — you’ve probably considered incorporating.
No business has to incorporate. In fact, 86.4 percent of all firms without paid employees are sole proprietorships, according to the Small Business Administration.
Finding the answer that’s right for you involves weighing the advantages, requirements and costs. Many small-business owners get help with this decision by hiring a professional — an accountant or lawyer who specializes in working with small businesses — for a one-time consultation.
Below are seven reasons why incorporating might be good for you. First, though, let’s take a quick look at the options for structuring small businesses, including incorporating:
Most small businesses use this, and it is the simplest route. You don’t have to do anything special to become a sole proprietorship, as long as you are the sole owner of your firm.
LLC (limited liability company)
Your business might face risks — the possibility of injuries to others, for example, or libel in the case of publications — that could put your home, savings or other personal assets at risk if your company lost a lawsuit. Structuring your business as an LLC protects your personal finances. Forming an LLC involves more paperwork than a sole proprietorship — which requires almost none — but less than forming a corporation.
There are two types of corporations, C corporations and S corporations. Both limit your personal liability and each offers advantages in specific cases. Forming a C corporation involves complying with more legal requirements and requires more bookkeeping than an S corporation, which in turn requires more paperwork than an LLC.
The most common — and easiest — way to incorporate
For most beginning businesses, incorporating is overkill. Money Talks News is an S corporation, but that’s because it was formed 25 years ago, when LLCs were less popular. Today, many experts view an LLC as involving the least hassle and having the lowest expenses to form. It also requires less reporting.
So why do businesses incorporate? Incorporating allows you to do the following:
1. Put a firewall between your business and personal life
Incorporating transforms a business into an independent entity that’s separate from its ownership. The owner might die or move on and management might change, but the incorporated business continues to exist until it is sold or dissolved.
This firewall offers a business owner a privacy buffer. When registering your company with the state where you do business, you’ll be asked to name a registered agent, a manager or owner who is the public contact for the company.
For privacy reasons, some owners prefer not to be named as the registered agent. Or, they may wish to list a business address that’s different from their home address. A corporation gives you the option of erecting this privacy wall.
2. Protect personal assets
Incorporating also inserts a legal wall between your business and personal life. This protects your nonbusiness assets in case your business is sued.
If your incorporated business loses a legal judgment, your personal assets generally are not at risk. A corporation’s debts belong only to the corporation. In case of bankruptcy, your personal assets are shielded as long as the corporation is properly structured.
3. Raise money
Another common reason to incorporate is to raise money for your business. In order to take on co-owners or issue stock by selling ownership shares, a company must be incorporated.
4. Add some polish
There’s something solid about adding “Inc.” to your company’s name. Acme Widgets Inc. just looks more credible than Acme Widgets. That stronger presence might convey greater trustworthiness or stability to your clients, suppliers and the world at large.
5. Compete for more contracts
Some businesses require vendors and contracting companies to be incorporated before they can compete for contracts.
6. Entice and hold employees with stock options
A corporation has an advantage in attracting talented employees: Corporate status allows owners to offer employees partial ownership in the business through stock options.
7. Establish credit in your business’s name
Small-business owners have two options for funding company expenses:
- Lend your company money from your personal assets and use your personal credit to apply for loans, lines of credit and credit cards for company use.
- Establish credit and apply for loans and financing in your business’s name.
If your company’s financial needs are or will be substantial, it’s best to establish an independent financial life for your business. Doing so will take time and will almost certainly require your personal guarantee when you start out. But as with any borrower, once your company’s credit is established, it will be able to borrow on its own.
This leaves your own funds and credit available for personal needs. Separating your business and personal accounts and records also helps insulate your personal finances from the business for purposes of taxes and limiting liability.
Are you a small-business owner? Share your experience in comments below or on our Facebook page.