As a small business owner just starting out, one of the most important questions you have to answer is just when should you incorporate your business? Some people will recommend putting it off as long as possible, while others will push you to incorporate before you open your doors. The truth is that every business is unique and thus every business has to determine its own timeline for incorporation. There is no one answer that fits everyone.
For most people, the first thing you should do is talk with an accountant or tax professional about your business plan in order to get advice from someone who can guide you through the advantages and drawbacks of incorporation for your particular situation.
Advantages of Incorporation
So why would you want to incorporate anyway? You can run many businesses quite comfortably as a sole proprietorship without going through incorporation. It’s quick and easy to set up, and makes it easy to start doing business without jumping through a lot of hoops. Still, there are a number of definite advantages to incorporating your business.
Limited Liability
One of the most significant advantages of incorporation is the liability protection it provides. When you set up a corporation, you create a new legal person that can take on the liabilities of the business. This makes it much more difficult for someone to go after your personal assets for the debts of the corporation. It’s not complete immunity, but it puts you in a much better financial situation if things go wrong, and every business owner needs to be prepared for just that eventuality.
Lower Tax Rates
Another advantage of incorporating your business is that businesses are subject to lower tax rates than high-income individuals. Depending on the amount of revenue your business makes in a year, these lower rates can lead to significant savings.
Easier to Transfer Ownership
Because ownership of the corporation is vested in the form of shares instead of personal ownership, it’s much easier to transfer some or all ownership from one entity to another. You simply sell or otherwise transfer the requisite number of shares and are done with it. This is particularly helpful when dealing with venture capitalists who will often fund your business for an ownership stake in the company. Incorporation makes it easier for them to buy in, and to sell out once it is time to recover their investment.
Greater Access to Capital
Incorporation also enables your business to take advantage of certain Federal Government programs that are only available to incorporated businesses. Many banks are also more likely to lend to incorporated This is in addition to advantages such as greater ability to benefit from working with venture capitalists mentioned above.
Anonymity
Depending on your personal position and the nature of your business, you may not want other people to know of your connection to the business. Because a sole proprietorship is essentially part of your personal finances there is no real way to maintain privacy. A corporation, on the other hand, does provide that privacy barrier so that you can keep the public from knowing your business.
Drawbacks of Incorporation
Looking at the list above you might think that incorporation is absolutely perfect and the right choice for any business at any time. Unfortunately, while incorporation does offer a lot of benefits, it does come with significant drawbacks as well, and you have to be able to balance them against each other before making the final decision.
Setup, Administration, and Overhead
When compared to proprietorships and partnerships, incorporated businesses require far more money and effort to set up and run. These additional layers of administration and overhead all add to the cost of running a corporation instead of a proprietorship. Smaller businesses often lack the resources to support this overhead.
Complexity and Regulation
One of the other drawbacks of a corporation is that it is subject to far more regulation than a sole proprietorship. There are two issues at play here: both the obvious issue of implementation, and the somewhat less obvious issue of simply knowing all the regulations you have to follow. This is one area where you really need to consult a professional.
Inability to Offset Losses
One important advantage to a sole proprietorship, especially when you are just starting out, is that you can use other income and assets to help offset business losses. This is not possible when you incorporate your business because incorporation builds a wall between your personal and business finances.
When Should You Incorporate?
So after considering all these factors, is there a way to know when your business should incorporate? Without knowing all the facts of the situation it can be difficult to make a hard and fast resolution but there are some situations where it makes sense for most business owners to make the leap.
When it Will Save You Money
One of the easiest times to make the decision to incorporate is when it will save you money. The more revenue that your business generates the more you are going to benefit from the lower tax rates and other tax advantages available to a corporation. This is why so many larger businesses incorporate; it makes better financial sense.
When You are in a High-Risk Industry
Not all business risk is created equal, and some businesses are naturally riskier than others. Take for example businesses like wedding planners, caterers, and photographers. All these businesses can serve people during high-stress situations, and it’s important to be able to protect your other assets if they choose to sue you.
Conclusion
If your business is in any way successful, there will come a time when you will want to incorporate. The question is when, and the answer is always when it makes sense for your business. If you’re not sure whether it’s time, consult an accountant or other professional who will be able to walk you through the decision so that you can determine the best time for your business.