Forming a Business Entity – An Ounce of Prevention Can Be Worth Pounds of Cure.
You’ve done your research, put in tons of hours developing your products or services, made key contacts, and now you’re ready to launch out on your own.
But not so fast…
Curb your enthusiasm for just a moment and think about the legal foundation of your business. You may have be running your business as a sole proprietorship and waiting to set-up any formal corporate structure because it makes money sense – avoiding initial legal start-up costs, working with an attorney, etcetera. Yet, you could be sued for any reason by a customer, employee, even a vendor. It makes great financial sense to spend a little up front to save you and your personal assets from financial ruin in the event of a lawsuit.
Setting up a business with by incorporating or forming an LLC you greatly reduce potential losses to you personally in the event of a lawsuit. Yet, the norm is just the opposite. According to BizStats.com, only 22% of all the small businesses in America are a limited liability corporation, S corporation, or C corporation. That means that over 72% of small businesses are operated as a sole proprietorship. The sole proprietor has just exposed their business and personal assets to huge risks. In addition, there is a 5-6 times greater risk of tax audit. The IRS has a division specifically aimed at the Small Business/Self-Employed for audit purposes.
Here are some reasons you should consider a formal legal entity:
Liability Issues: A corporation or LLC is a separate legal entity from you and your personal assets. Any debts incurred solely by the business entity or lawsuits brought are against the company, not the owner. By establishing a proper legal foundation through a formal business entity a barrier is erected between your personal assets and potential business lawsuits.
Taxes: They are inescapable, but a benefit to forming a business entity is the reduction of taxes. And the dreaded IRS Audit Letter is significantly reduced because the IRS views incorporated companies or LLC’s as being “legitimately” in business versus a sole proprietor. The peace of mind that comes from knowing an IRS audit is less likely, plus the additional deductions afforded to business entities make is good money sense.
Building and Expanding the Business: Here’s the bottom line – if your business is not incorporated as an entity separate from you, you not in a real business. If you’re serious about providing for you and your family then treat your business like a real business (and incorporating it is the first step), and you will see your income grow.
Raising Capital: Let’s face it; the credit universe has shrunk. There is no more free flowing credit. But trying to obtain financing for as sole proprietorship or even a partnership is nothing more than a black hole. If you are going to pursue a business loan or even a line of credit you will need to a have a separate business entity, lenders are looking for “legitimate” businesses. The added benefit is that the business will ultimately be responsible for the loan, freeing your personal assets from any risk.
Selling the Business: Should your long-term goal be to sell your business, a separate business entity will make this process easier from the start. A business needs to be valued and pulling a number out of thin air just won’t work. Extracting a value from a business that is not separate from you and your personal assets is virtually impossible to value and sell.
While just putting up a sign and opening up a shop seems to make money sense, the value of setting up a business entity is the key to having a real business instead of just creating another job for yourself.
With any serous business venture, always consult an attorney to determine what’s best for your business.