Small business owners worldwide start their companies as sole proprietorships, but once your business starts taking off, the idea of incorporation starts being considered. When considering incorporation, it’s essential to build familiarity with Articles of Incorporation, recommended timing of incorporation, and the numerous benefits incorporating can provide compared to a sole proprietorship. You are encouraged to explore multiple considerations as a small business owner when it comes to incorporating your company and how timing can either positively or negatively impact your company’s future.
What Does “Incorporate” Mean?
The term “incorporate” refers to the process of turning your sole proprietorship or general partnership into a company that’s formally recognized by the state your business resides in. Incorporating allows your company to become its own legal business structure set apart from the founding individuals. As the company’s owner, you and any other owners will create a separate legal entity like a corporation or limited liability company (LLC) to transact business. The separate legal entity changes how your business is viewed through the law’s eyes and will likely give you more credibility with potential customers, vendors, and employees.
Choosing to incorporate your business comes with many benefits, but the most prevalent is limited liability. Small business owners invest a substantial amount of money into their business model, from launch to overall maintenance. You’re likely familiar with the debts and losses you can face along the way as a small business owner. Incorporation allows you only to be held responsible for funds you personally invest, meaning your personal assets cannot be used to minimize your business’s debt and liabilities.
The Process of Incorporating
If you’ve been considering incorporating your business as an S-Corp, C-Corp, or LLC, it’s recommended to become familiar with the general process. There are many differences between these three primary ways of incorporating your business to include tax rates. While each state differs in the incorporating process, there are many similarities. Below is a brief overview of the steps included in the overall incorporating process:
- Identify the state where you would like to incorporate
- Research each business type and determine which is best for your business and goals
- Seek guidance from a business lawyer or accountant, if applicable
- Appoint directors of the corporation and members or managers of the LLC
- Choose the individual or registered agent who will receive legal and tax documents regarding your business on your behalf
- Research and identify which business licenses will be required for your company
- Under the instruction of your Secretary of State’s office, prepare and file the Articles of Incorporation for your business
At times, it can be challenging to understand the difference between each type of incorporation, which is where seeking guidance and advice from a business lawyer can be helpful. A business lawyer will explain each kind of incorporation and consider your unique needs and company structure to help you choose the best type for your situation.
Understanding the Right Time to Incorporate
There are many details that factor into choosing the best time to incorporate your business. It’s important to remember that every business is different based on a unique set of needs, market focus, and more. Whether you’re choosing to incorporate early for advantages, hiring employees, or selecting partners or co-owners, we’ll explore each of these scenarios one-by-one.
Incorporating your business early on can be noticeably beneficial compared to later. These benefits apply to any business type you choose, from S-Corp and C-Corp to LLC. The topics listed below are a few examples of how your company can benefit by choosing to incorporate early on.
- Instilling a Professional Image: Your company’s credibility and status will enhance when you become a corporation or LLC. Businesses that become incorporated not only stand out from the competition but end up attracting more customers.
- Simplified Financing and Funding: The typical lender tends to prefer businesses that are incorporated and are more likely to provide a loan or other financing. As a sole proprietorship, your personal and business assets are closely intertwined, which can be risky for a lender. Additionally, investors can invest in a share of your business as a corporation or LLC, unlike a sole proprietorship.
- Potential Tax Advantages: While it’s recommended to check with your accountant or tax advisor on whether this applies to your unique situation, incorporating your company could help lower your tax bill. Potential tax advantages are based on several factors, from reinvesting income and your personal income tax rate to whether you’ll be drawing a salary.
- Limited Liability Protection: It’s essential to consider the risks that come with sole proprietorship as you will be held responsible for debt, fees surrounding an accident, and more. As a corporation or LLC, the entity is liable for its debts rather than the owner, shareholders, or other members.
While there are many benefits to incorporating early on, it’s also essential that you consider potential downsides. Forming a corporation or LLC is usually more expensive than operating as a sole proprietorship because of fees and other required items, such as maintaining records, filing annual reports, and more. If your company is a sole proprietorship and you choose to end business, you simply stop operations. However, as a corporation or LLC, you will be required to participate in a formal dissolution process before halting business which can be costly.
Before Contracts Are Signed
Choosing to incorporate usually protects your personal wealth from any business liabilities, and this is applicable for both online and brick-and-mortar entities. It’s recommended to incorporate or form your LLC before signing any contracts as this will eliminate any potential obstacles. Since corporations and LLCs have their own legal existence, any signed contracts, financing or funding, and owned property are in the company’s name. You will not be required to use your personal assets, and personal assets cannot be reached by creditors should a situation arise where this is necessary.
Establish Ownership Roles
Incorporating early will help you establish a clear understanding of ownership and financial and management rights for each owner. Determining each owner’s role and rights will keep your business organized and allow it to grow effectively in the future. Establishing ownership roles will also help prevent any future misunderstandings and clarify who owns or owes what.
Whether you already have employees or intend to bring employees on, incorporating before any employees are hired is beneficial. As an employer, it’s not unusual for you to be held liable for an employee’s mistakes or actions during their employment with your company. If your business remains a sole proprietorship, you will be held liable, and your personal assets will be at risk. Whereas, if you’re incorporated as a corporation or LLC, the entity will be held liable without placing your personal assets put at risk.
Partners or Co-Owners
If you’re planning on adding partners or co-owners at any point, considering forming a corporation or LLC is recommended. Should a general partnership be formed without incorporating, all individuals will be put at a similar disadvantage as a sole proprietorship. These disadvantages include being held personally liable for any incurred business debt. Incorporating as a corporation or LLC will also clearly identify what portion each partner or co-owner owns of the company, who has the credibility to make decisions regarding the business, and more.
Immediately following your decision to start a business, it’s essential to explore and consider the numerous incentives that early incorporation can bring. Early incorporation offers a range of benefits compared to a sole proprietorship, from contracts and other documents being signed in your corporation or LLC name to a simplified hiring process and partner or co-owner additions. If you’re unsure of what is best for your company, seeking advice from a business lawyer can be extremely helpful. Keep in mind, the sooner you decide to incorporate, the sooner you can develop a clear understanding of how your company will benefit in the future, both with and without incorporation.