My friend that I mentioned previously in the Webstore Chronicles post, asked if he should form a corporation for his business. I fairly quickly told him no, that he doesn’t need to incorporate. However, the reason for this response might not be so clear to some. Hence this post…
Please remember that this is my personal commentary on whether or not to form a corporation. If you’re getting serious about your business, I recommend you read a few books on the topic and possibly even talk to an attorney. (Just about every “guide to starting a business” will have a section explaining the different business structures.)
Before we move on, let’s review the various business structures:
1. Sole Proprietorship
Basically, anyone that performs a service is automatically considered a sole proprietorship unless they specifically set up another business structure. Generally, a sole proprietorship consists of a single person or a few employees. However, there is absolutely no limit on the size of your sole proprietorship. Technically, even a company the size of Wal-Mart could be a sole proprietorship, but it usually makes sense for larger businesses to use a different business structure.
2. Partnership
When two people start a for-profit business, it’s considered a partnership. There’s usually, *and should be*, a written agreement covering the distribution of revenue, as well as what would happen if one or both of the partners chose to leave the business. In most states, disputes are handled under the Uniform Partnership Act (UPA). A partnership is basically a sole proprietorship, but with 2 people. If you go into business with a partner, no matter how utopian the initial arrangement is, please make sure to write up a detailed partnership agreement. You’ll appreciate it if things ever turn sour.
3. Corporation
When you form a corporation, you’re actually creating a new legal entity. This new entity can do just about anything a person can. It can get credit, make a profit, and get sued. To form a corporation, you need to complete several incorporation documents specific to the State of incorporation. When the corporation is created, shares of stock are issued to shareholders. These shareholders trade something of value, such as money or expertise, for their shares. These shares are created regardless of whether the corporation is public or private. If your corporation is private, all of the shares could be owned by yourself, or maybe by some close friends and family. Once your corporation goes public, anyone may buy shares of your company at the going price.
Corporations are also divided into C-Corporations, Subchapter S Corporations, and Limited Liability Corporations (LLC). Large companies generally form C-Corporations, while smaller companies usually choose an S Corporation or LLC. There’s less paperwork and regulation on the latter two as long as they follow certain guidelines.
Ok, so why shouldn’t I form a corporation?
There are several myths out there as reasons one should incorporate a business. The top 2 are tax savings and personal liability.
Ok, now to disspell those incorporation myths:
1. Tax Savings
I’ve read so many times on the Internet that I should form a corporation for the tax benefits. They usually go something like this: “If you form a corporation, you can write off business expenses, business meals, and even a portion of your mortgage!”
However, you can do all of these as a sole proprietor! I have owned my own business in one form or another for the past 10 years. Every year, I was able to deduct business expenses. (Always consult a tax attorney.) I wrote off equipment, meals, travel expenses, part of my mortgage, part of my utility bills, even some supplies to spruce up my office. The key is that a sole proprietorship is a business. As a business you can deduct your business expenses from your income. (Again, I’m not a tax expert. This is just my experience.)
I did form an LLC a few years ago and the only difference was that I paid a bunch of money to fill out a bunch of forms and follow a bunch of rules. Then, at tax time, I got a penalty because I didn’t dot all of the i’s and cross all of the t’s. Thank you, I’ll choose a sole proprietorship every time.
2. Personal Liability
First, I will admit that this is mostly true. Technically, the corporation is a separate entity, and if it is sued, your personal assets cannot be taken. If you are running an honest business and someone slips when leaving your house after a meeting, this business structure should stop them from being able to take your house. I’d say an exception to this entire post would be if you are running a brick and mortar business. You could absolutely have a slip and fall situation and you’ll be glad to have this layer of protection. On the other hand, if you’re starting a wholesale business, or other venture that is almost entirely online, you’ll have a tough time convincing me to incorporate.
HOWEVER…This does not mean you are exempt from all responsibility. If you personally are negligent or dishonest in your business dealings, a judge will come after your personal assets every time. Many judges are looking to determine why you formed your corporation. If they find that it was so you could rack up huge debt and/or scam your customers, expect the corporation to be sued, but you can bet you’ll be named as a co-defendant. Yep, that means YOU are personally responsible for everything.
One more note…
For me, I initially wanted to start a corporation for every business I started. There’s something about forming a corporation that makes if feel like you’re running a business. I thought if I had a corporation, it meant I was big-time and it would help the business to be a success. While it does feel that way, I must stress that it doesn’t matter how much “like a business” your business is. It’s the goods and services you provide to your customers. If those are good, then it doesn’t matter if you are a corporation with your own office building, or a sole proprietor working out of your cold, dark, unfinished basement.
So, if you’re running an honest, online business, you really shouldn’t have very much risk of being sued. So why go through the hassle and expense of forming a corporation? I’ve done it once, and will never do it again unless I absolutely must.
