When someone starts a business, he or she almost always begins the venture as a sole proprietorship, legally speaking. It is not hard to understand why that is: A sole proprietorship is the easiest, quickest, and least expensive way to get started. Moreover, when you are starting a business there are usually a lot of other, seemingly more pressing things at hand – naming it, finding space, getting the money, and so on and so on.
But you may notice that I said that these things are “seemingly” more important. I say that because I am an attorney, yes (although I have since come to my senses and don’t practice anymore), but also because it’s correct. A sole proprietorship is actually a very risky way to run a business. Better: You should incorporate. Here’s why:
1. It protects your personal assets: This is the most important reason. Let’s say that you own a computer consulting business. One day, one of your staff members heads out to a job and installs a new system for a client. But oh no! He did it wrong. The client ends up losing a lot of data. While you may have some insurance that will cover the loss, you may not, and either way, the client can sue you personally if you are still running your business as a sole proprietorship. That means that your home, retirement, and all other assets are at risk.
A corporation is a separate legal entity, apart from you. It sets up, as it were, a firewall between your personal assets and the business assets, creating what is called “a corporate shield.” Sounds nice, eh? We all would like to have a corporate shield. But you only get one if you incorporate.
There are basically three types of corporations you could choose:
- C Corporation
- S Corporation
- LLC – A Limited Liability Company
While there are pros and cons to each one that are too complicated to get into here, but the important thing is to check them out and figure out which is best for you.
2. It will help you establish business credit: As long as your business is a sole proprietorship (or for that matter a partnership), your personal credit is the business’ credit. Once you incorporate, however, and get a taxpayer ID number from the feds, and you begin to separate your personal from your business life, you also can begin to establish credit in the name of the business.
3. It looks better: Having an “Inc.” behind the name of your business just looks good. People tend to take it more seriously. And if you ever need a bank loan or some outside investors, being incorporated signals to them that you understand business and are worthy of a second look.
All in all, incorporating is almost always the way to go.