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 the 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 turning your sole proprietorship or general partnership into a company formally recognized by the state in which your business resides. Incorporating allows your company to become its 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.
Incorporating your business comes with many benefits, but limited liability is the most prevalent. Small business owners invest substantial money into their business model, from launch to overall maintenance. You're likely familiar with the debts and losses you can face 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 considered incorporating your business as an S-Corp, C-Corp, or LLC, becoming familiar with the general process is recommended. There are many differences between these three primary ways of incorporating your business, including tax rates. While each state differs in the incorporation 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
Understanding the difference between each type of incorporation can be challenging, whereas seeking guidance and advice from a business lawyer can be helpful. A business lawyer will explain each 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
Many details factor into choosing the best time to incorporate your business. It's important to remember that every business differs based on a unique set of needs, market focus, and more. Let's explore each scenario individually, whether you're choosing to incorporate early for advantages, hiring employees, or selecting partners or co-owners.
1. Early On
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 incorporating them 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 stand out from the competition and attract more customers.
- Simplified Financing and Funding: The typical lender prefers incorporated businesses and is likelier 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 checking with your accountant or tax advisor on whether this applies to your unique situation is recommended, 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 draw a salary.
- Limited Liability Protection: It's essential to consider the risks of the sole proprietorship as you will be held responsible for the 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, etc. If your company is a sole proprietorship and you choose to end business, you simply stop operations. However, as a corporation or LLC, you must participate in a formal dissolution process before halting business which can be costly.
2. Before Contracts Are Signed
Incorporating usually protects your personal wealth from business liabilities, which applies to online and brick-and-mortar entities. Incorporating or forming your LLC before signing any contracts is recommended, as this will eliminate any potential obstacles. Since corporations and LLCs have their 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.
3. Establish Ownership Roles
Incorporating early will help you clearly understand each owner's ownership and financial and management rights. 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 misunderstandings and clarify who owns or owes what.
4. Hiring Employees
Whether you already have employees or intend to bring employees on, incorporating them 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. If you're incorporated as a corporation or LLC, the entity will be held liable without risking your personal assets.
5. Partners or Co-Owners
If you plan on adding partners or co-owners at any point, considering forming a corporation or LLC is recommended. Should a general partnership be formed without incorporation, 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, exploring and considering the numerous incentives that early incorporation can bring is essential. Early incorporation offers a range of benefits compared to a sole proprietorship, from contracts and other documents 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. Remember, the sooner you decide to incorporate, the sooner you can understand how your company will benefit in the future, both with and without incorporation.