If you are at the point where you have either started a business or have decided to start a business, one of the many questions that are probably running through your mind is whether to incorporate. For purposes of this article, when I say “incorporate” or “incorporation”, I am really speaking broadly about forming an independent entity, be it a corporation, limited liability company or otherwise. There are numerous reasons why incorporation could benefit you as a business owner, including, although not necessarily limited to the following:
(1) Limited Liability: Perhaps the most important benefit of forming an entity like a corporation or a limited liability company is the liability protection. If an entity is formed and appropriate formalities are maintained, a debt or liability of the entity remains only a debt or liability of the corporation. Generally, a shareholder’s liability in any corporate debt or liability is limited to what the shareholder invested in the entity. Conversely, in a sole proprietorship, where the business owner did not form an independent entity, the owner(s) remain liable for all debts and liabilities of the business.
Similarly, and perhaps just as importantly, for those starting a business involving multiple owners, a debt or liability of a specific shareholder remains separate from the corporation. For example, let’s say your business is reliant on an asset, say a truck, and that truck is purchased by your partner whose name remains on the title. If your partner is sued, even for something unrelated to the business, the truck could be used to satisfy whatever judgment or liability results from the lawsuit, since it is still held in his/her name. Obviously, this would deprive the business of the use of an important asset and create a problematic situation, especially, if your business is reliant on that truck! If the asset was owned by the corporation, a lawsuit against a shareholder would not impact a corporate asset.
In sum, among the benefits of limited liability through the creation of a corporate identity are (1) that it allows the corporation to conduct business without the risk of endangering the shareholders’ personal assets beyond what was invested in the business, (2) it protects assets that the business relies on from liability of its shareholders, and (3) as an added benefit, minimizing these risks results in a more attractive opportunity for potential investors.
(2) Insurance: As stated previously, the owner of an unincorporated business may be held liable for the debts and liabilities of the business. Liability insurance is often considered a solution to this problem; however, such a solution leaves a business owner reliant on their insurance provider. Relying on the right insurance company, policy and broker may not result in a problem, but you won’t know whether your faith in your insurance company, policy and broker is misplaced until it’s too late. Moreover, your insurance policy may not cover everything. Should the insurer seek to disclaim coverage, whether rightly or wrongly, the business owner’s assets could end up being used to satisfy the debt or liability.
(3) Continuity: As previously mentioned, by incorporating a business, the personal finances of an owner are separate from the finances of the corporation, which allows the business to continue with less disruption in the event of an unexpected death of a shareholder or any other unforeseen event. The corporation can continue in perpetuity, regardless of what happens to its shareholders, directors, and/or the employees. On the other hand, without a corporate structure, where business finances are mingled with personal finances, an event like the unexpected death of an owner, will likely cause a major disruption and could even force dissolution of the business, despite the owner’s wishes to the contrary.
(4) Transferability: Incorporation makes an ownership interest in a business more easily and clearly transferable. The ability to easily transfer an ownership interest is desirable if the owner decides to sell, but also if the owner decides to seek additional investors.
(5) Professionalism: Finally, incorporating establishes a professional identity and appearance. Such a professional identity and appearance will help build credibility with customers, patrons, vendors, landlords, and lenders, among others.
If you enjoyed this edition of the Innovator’s Counsel, you’ll be able to access it and previous postings at https://kcl-law.com/kcl-law-blog. Also, if you would like to speak with me, or have any questions or topic suggestions, please feel free to email me at [email protected].