Should You Incorporate?

Scales of JusticeWhether to incorporate or form some other type of limited liability entity to operate a new business is a question frequently asked.

I’ll give you some food for thought in this article.

To Incorporate or Not – That Is the Question

I have no statistics to back me up on this, but my guess is that most people starting out to do business online do not incorporate or form a limited liability company.

In fact, I would be so bold as to suggest that the majority of new internet marketers never even consider whether they should form a business entity or not.

I’ll discuss the selection of entity type and the formation process in a future article, but let’s look at what may be the main benefit of forming an entity through which to conduct your business.

The threshold question is, “why incorporate?”

In this context, when I use the term “incorporate” I am making a generic reference to forming some type of entity under which to conduct your business.

The most common entity choices in the United States are corporations and limited liability companies (LLCs), with the nod going to LLCs for popularity in recent years.

Asset Protection & Limited Liability

Regardless of the type of entity chosen, why go through the headache of forming the entity in the first place?

Like everything in today’s world, there’s paperwork to be done and some fees to be paid to regulatory agencies during the formation process.

Probably the overriding reason for choosing to form an entity through which to conduct your business is asset protection. Incorporating separates your personal life and assets from your business activities.

It is estimated that 90% of businesses will be involved in litigation. Most people these days are very aware of how litigious our society has become.

People hoping to recover cash settlements from companies are filing suits over trivial and even ridiculous matters that would never have been considered years ago.

The reality is that litigation is expensive and even if you are 100% in the right, the costs of litigation can make your best option paying a cash settlement to make the complainant go away.

Sadly, some lawyers and their greedy clients are well aware of this.

One important fact that prospective plaintiffs (and their lawyers) consider is whether you have “deep pockets,” meaning a lot of assets or insurance, from which they can recover.

Most attorneys are smart enough to realize that it is a waste of time to sue a company or an individual who has no assets.

Sure, they may get a judgment, but that’s just a piece of paper signed by a judge. If there are no assets available to satisfy the judgment, the attorneys aren’t going to waste time prosecuting the claim for the prospective plaintiff.

So, let’s suppose that you are fortunate enough to have accumulated some assets like your home, savings, investments, and retirement accounts.

Plaintiffs and their lawyers are likely to conclude that you have “deep pockets,” making you a better target for lawsuits than someone with less net worth.

Therefore, if you are considering starting a business, online or offline, perhaps you should do what you can to insulate your personal assets from our litigious society.

That’s where incorporating comes in.  The concept is to form some type of limited liability entity through which to conduct your business activities.

When you do so correctly, the law makes a distinction between you personally and your business entity, which is regarded as separate and apart from you – even if you own 100% of the stock in the company.

The distinction between you personally and your company is what makes incorporating a useful step in asset protection.

These entities (corporations and LLCs) are often referred to as “limited liability entities,” meaning that the personal liability of their owners is limited.

If your company gets involved in litigation, whether deserved or undeserved, it is only the assets owned by the business entity, and not your personal assets, that are subject to any recovery a plaintiff might obtain.

Therefore, your personal residence, personal investments and retirement accounts are not at risk for the activities of the business.

On the flip side, if you do business without forming a corporation or LLC, then you are what is called a “sole proprietor” and your personal assets are subject to the liabilities of the business.

So, if a large judgment is rendered, you could lose everything, with only a few limited exceptions!

There are, of course, other reasons to form a limited liability entity through which to do your business, but asset protection is certainly one of the major considerations.

Lest you think forming a corporation or limited liability company is all roses, you should also be aware that there is a downside too.

First, there are the initial start-up costs involved in forming the entity and getting it set up and running.

Once that is done, there is an added layer of paperwork involved in keeping the separate books of the entity and making the necessary filings with local, state and federal agencies.

Summary

It basically comes down to a cost-benefit analysis based upon your personal situation and the kind of business activities in which you intend to engage.

If you have significant personal assets and/or will be engaged in a high risk activity, then forming a company to do your business will be worth the extra expense and paperwork.

If you have little or no personal wealth at this point, then when you weigh the cost of establishing the entity against the minimal benefits you would derive at this point in your career, it may not be worth the effort.