***Note: Only a corporation is incorporated. An LLC is an unincorporated entity. It is more accurate to say that an LLC is formed or organized. However, for simplicity, I am using the term incorporate to include both corporations and LLCs. And you can read this blog regardless of the type of entity you have or are contemplating creating.***
So when is the ideal time to incorporate your business? Speak to an experienced attorney at George Law, (248) 470-4300.
Below are some key considerations to bear in mind.
- Incorporate Early to Reap the Benefits
It’s generally beneficial to form your company earlier rather than later. This is true regardless of the type of business and whether you decide to create a C corporation, S corporation, or LLC.
Benefits you will gain by incorporating early include the following:
Present a professional image to customers, suppliers, and investors – Becoming a corporation or LLC enhances your credibility and status. As you are trying to establish and build relationships, having the “Inc.” or “LLC” attached to your name gives you an edge when competing for business. Another consideration is to own the web domain in the name of the company. These things just help you appear more professional, and appearances are important.
Greater ease in obtaining financing and funding – Lenders generally prefer an incorporated business and may hesitate to provide a loan to a sole proprietor. Sole proprietorships are often considered riskier because there is no separation between the owner’s personal assets and the business (meaning the owner can spend their money on themselves instead of the business). And some investors want a share of the business, which cannot be done in a sole proprietorship but can be in a corporation or LLC.
Possible tax advantages – Incorporating your business may lower your tax bill, though you should check with your tax advisor. Whether it will depends on a number of issues, including your personal income-tax rate, whether you will reinvest income, and whether you will be drawing a salary.
Limited liability protection – Operating as a sole proprietorship invites risk. In the eyes of the law, there is no difference between your personal assets and those of your business. If your business incurs debts (if you can’t pay your suppliers or commercial lease, for example) or an accident occurs, then you are personally liable for them. If a corporation or LLC owns the business, that corporation or LLC is liable for its debts, not its shareholders or members.
- Incorporate Before You Sign Contracts to Enjoy Limited Liability Protection
As mentioned above, incorporating your entity can protect your personal wealth from business liabilities. This is true for online businesses as well as brick-and-mortar businesses.
Corporations and LLCs have their own legal existence. The corporation or LLC can sign contracts, borrow and lend money, invest, and own property – all in its own name. The person who owns the corporation or LLC does not have to use their personal assets. Creditors can pursue the business assets but generally cannot reach your personal assets.
Note: If you sign a contract as a sole proprietor and later incorporate, you are still individually liable on that contract. For that reason, it’s generally better to incorporate or form your LLC before signing contracts, leases, franchise and other agreements, etc.
- Incorporate Early to Establish Business Interests Among Founders
If a business has more than one founder, a clear understanding of ownership interests helps the business grow harmoniously, efficiently, and effectively. In some businesses, the intention is for all the owners to be equal. But in others, the intention is for some owners to have more financial or management rights (and obligations) than others. By incorporating early, and setting forth each owner’s financial and management rights in the governing documents, you can prevent future misunderstandings and keep everyone on the same page regarding who owns what and who is owed what.
If your business owns intellectual property (copyrights, trademark, patents) or other property, incorporating generally is an important step in ensuring the business owns that property rather than any individual founder.
- Incorporating Before You Hire Employees Helps to Protect Your Assets
Businesses expect to have employees should incorporate before hiring them. Employers are generally liable for their employee’s actions and mistakes that occur in the ordinary course of their employment. If you run your business as a sole proprietorship, you are individually/personally liable and your personal assets are at risk. However, if you have incorporated, the corporation or LLC is the employer and takes on this liability risk.
- Incorporate Before You Add Partners or Co-Owners
Another good time to consider forming a corporation or LLC is when a sole proprietor wants to bring in a business partner as a co-owner. General partnerships (which are what are formed when two or more people go into business together without incorporating) have the same disadvantages as sole proprietorships – in particular, personal liability for the business’ debts. In addition to affording liability protection, corporations and LLCs make it easier to tell who owns how much, who has decision-making authority, etc.
- Are There Downsides to Incorporating Too Early?
One downside to forming a corporation or LLC is that it is more expensive than operating as a sole proprietorship. There are fees for incorporating and then annual fees. Also, there are other compliance requirements – you have to maintain certain records, appoint and maintain a registered agent, file annual reports, hold shareholder meetings, etc., that sole proprietorships do not have to deal with. In addition, if you decide to discontinue the business, as a sole proprietorship, you just have to stop doing business. Corporations and LLCs have to go through a formal dissolution and winding up process. So, if you are only in the planning stages of starting a business, you may wish to hold off incorporating until you have more concrete plans for important matters such as contract relationships, hiring employees, and taking on partners.
Once you know you’re starting a business, you’ll find that there are many incentives for incorporating earlier in the process. You will be able to sign contracts and other documents in the corporation’s or LLC’s name and take far greater advantage of the limited liability and other benefits incorporation can offer.
If you have questions, feel free to call George Law at (248) 470-4300. George Law has experienced lawyers to guide you in all stages of your business.