There are many reasons why a small business owner might decide that it’s time to create a legal separation between him or herself and the business. In general, the decision is spurred on by one of two things: the business is growing, or the original owner is planning to leave.
Lots of important steps that a small business takes toward major growth are made possible by incorporation. They include:
Larger Risk: If you’re only doing a small amount of business, you probably aren’t at much risk for huge lawsuits. Once your business starts to boom, however, the risk of a large legal battle increases very quickly. If your business isn’t incorporated, your personal assets are all at risk. Once the business is a legally separate entity, there is a protective barrier between money that belongs to the business and money that belongs to you, personally.
This goes for taking credit out for your business as well. If your business isn’t incorporated, any loans or credit lines you use to fund it will be against your personal assets. If the business fails, you’ll still be on the hook for the debt.
Stock: You can’t sell or give away stock in a company that doesn’t (legally) exist. If you’re looking for equity investors to bring your business to the next level, or high-functioning employees to add new capabilities to your operation, then being able to sell stock, or give stock options, is a major advantage.
Taxes: If you run a small business that isn’t incorporated, then you pay taxes on your business income, and on your personal income from the business. Certain corporate structures (such as LLCs or S corps) can allow you to pay taxes on that business income only once. If your business qualifies for that special tax status, you could save a lot of money.
Geographic Expansion: If your business is opening a new location in another state, or will otherwise be doing business in multiple states in the US, then incorporating is a priority. Luckily, you may be able to choose between the states you work in for where to incorporate. That could give you a choice between taxes and fees and such. Make sure you consider all your options.
The other reason you might want to incorporate your small business is if you plan to leave it one day, but want it to continue. On a morbid note, if your business is a sole proprietorship or a partnership, and you die suddenly, the business or partnership contract ceases to exist, from a legal standpoint. If you and your business partners are starting to think long term, then establishing the business’s legal identity as separate from your own ensures that it will carry on even after you are gone.
Hopefully, you now have a better idea of what might convince a small business owner to incorporate their business. However, you shouldn’t overthink it. Over two-thirds of US businesses are not incorporated. Most small businesses simply never need the protections or benefits that incorporating provides, so they opt out of paying all the fees and doing all the paperwork.
Odds are, your business doesn’t need to incorporate. But if it does, now you’ll know why.
