4 Reasons to Incorporate Your Business
"When should I incorporate?"
This is a very common question entrepreneurs face while starting their business. When a business is incorporated, a separate legal entity is formed from those who created it which can have a big impact on the future of your company. A corporation has the same rights as an individual. It can own property, conduct business, incur liabilities, sue or be sued, sign contracts, hire and fire employees, etc. Below are 4 reasons why you should considering incorporating your business early on in it’s life.
1. Personal Asset Liability Shield
The primary purpose of incorporating a business is to create a liability shield between the individual owners and the company itself. This means that those in charge of running the company - the Founders, Board of Directors, Officers, Shareholders - will not be personally liable for the financial obligations of the company (such as debts and legal judgements). Contrast this to sole proprietorships and partnerships, where individuals are directly liable for all the business’s debts and claims and their personal assets can be taken by the court or creditors. This liability shield serves to incentivize the creation of companies, thereby sparking economic growth. The earlier you incorporate, the less personal risk you and the other owners take-on.
2. Internal Organization - Ownership & IP Protection
Incorporation creates an internal organizational structure that lays out the details of company ownership and shareholder rights, ensuring that everyone is protected and on the same page before any issues arise. This is particularly important when it comes to the company’s intellectual property, especially if it’s co-owned. In the vast majority of circumstances, it is best to assign the IP to the company when issuing stock to co-founders. This should be done immediately upon incorporating and early on the company’s life. Doing so will avoid future problems surrounding exclusivity and co-founders leaving and taking their IP with them.
Additionally, incorporation makes raising money and hiring excellent talent easier. Once incorporated, an individual’s ownership interest and the option pool, represented by the shares of stock held, can be easily sold, transferred, or given away. The ease of transferability of shares, in addition to the limited liability, is very important to investors and key hires.
3. Tax Considerations
There are many tax implications when incorporating and should be discussed in detail with an accountant to determine which structure is best for you. One good tax reason incorporate early and not wait until you’ve raised money is that investments can influence the fair market value of your company’s compensatory stock (stock exchanged for services). If stocks are issued to founders at a nominal value prior to investment, when the company has little to no real value, the founder’s receive in inconsequential amount of taxable income. However, if founders wait to incorporate until after they receive funding, the founder’s stock could be influenced by the price investors paid in their shares, leaving them with a big tax liability even if they have no way to pay it.
4. Permanence
Once incorporated, the business has the ability to continue indefinitely and is not affected by the death of shareholders, directors, or officers. The business will go on under different management and employees, creating durability and permanence of the entity. While this may not seem important when you’re first getting started, it’s always smart to plan for the unexpected.
Incorporate Early!
Entity formation provides a personal liability shield, ownership protection, organization structure, potential tax benefits and creates permanence. If you’re questioning whether or not you need to incorporate, the likely answer is “yes.” There are many do-it-yourself services online today to do it cheaply and easily. This may be a good option for experienced business owners if you know exactly what you need and how it plays into your business goals, both short and long term. However, there are many nuances when it comes to picking the right entity and I highly recommend you speak to an attorney before forging ahead.