Incorporating for Small Business...

Is It the Right Business Structure for You?

Incorporating for small business may not be the right business structure for your business. There are business partnerships and other legal entities you may want to consider instead...

As you develop your business idea, you will have to decide on your choice of legal entity. What a lawyer is referring to when he talks about the "choice of entity" is the legal form your business will take.

As an owner, you can be held liable for injuries and damages, even for the debts incurred by your partners. Will you want to eventually sell your ownership interest? Invest capital? Defer taxes? Will you run your business alone? Take partners? Considering a not-for-profit? What about a franchise?

Choosing your legal entity, whether incorporating for small business or something else, will govern many aspects of how you run your business. So deciding on which to use is one of your more important decisions as you set up your business.

This is not the time to perform your own brain surgery!

Hire a lawyer to help you make an informed decision.

What Are Your Choices for a Business Structure?

Incorporating for small business is not the only option... In a practical sense, most businesses will take one of three forms:

• Sole proprietorship
• Business partnerships
• Incorporation

Each structure has its own benefits and concerns. So get proper guidance before you jump in. Let's take a closer look at each one...

Sole Proprietorship

Sole proprietorships are the simplest form of business structure, with low maintenance costs and minimal requirements. Just hang up your sign and you're open for business.

You run your business in your own name and are personally liable for all the obligations. The sole proprietorship ends when you do (i.e., when you die), and the property of the business is distributed according to your will.

On one hand, sole proprietorships are very desirable because of their simplicity. On the other hand, if you're planning to have a more sophisticated business, you may need another entity.

Business Partnerships

There are 2 different kinds of business partnerships... general partnerships and limited partnerships.

General Partnerships

General partnerships have two or more partners, each with unlimited personal liability for the obligations of the business. Each partner has complete and equal control, unless you have a partnership agreement stating otherwise.

In a partnership, there are no directors or officers, just partners. The Partnership doesn't pay taxes like a corporation does. Instead, the partners pay taxes individually on their own income.

Partnerships can be risky because each partner is liable for the partnership liabilities – and your personal assets might even be seized to pay them! Imagine your partner taking out a loan from a bank in the business' name. Who is liable? The partnership, and that means you.

Two people who simply say to each other, "We're partners!" may be partners under the law, even without a formal procedure. Still, you can see that it's a good idea to get your lawyer to draw up an agreement that reflects your needs up front, while you're still all optimistic and friendly.

Limited Partnerships

In a limited partnership, partners are only liable to the extent of the money they contribute. The general partner retains personal liability for the partnership debts.

Even so, the limited partner may be held liable if he's found to control the business beyond the allowed limited role.

But what is the boundary of a limited role? How much participation is too much?

Good question. Get help from your lawyer to get the clearest definition, and avoid bad surprises later.

Incorporating for Small Business

Corporations have a kind of legal immortality. A corporation is an autonomous legal entity, existing apart from its shareholders, officers and directors.

Corporations usually have the same powers as an individual person: own property, sue in court, sell or transfer property, etc.

Unlike business partnerships and sole proprietorships, corporate shareholders are not liable for any of the corporation's debts. This means that what you pay for the stock or what you pay to incorporate is all you're risking.

With incorporating for small business, even if you own 100% of a business and make every decision, you cannot be held liable for the debts of the corporation, except in the case of fraud.

Most lenders (banks, investors, etc.) will make the principal owners sign personal guarantees for the loans made to the corporations (we are talking about money, after all), so you will still likely be on the hook for some of the company's liabilities.

And because a corporation continues on regardless of the circumstances of the owners, these obligations could affect your estate even after your death.

You should be aware of the costs of incorporating for small business – filing fees, initial organizational documents (where you agree about things like the number of directors, corporate officers, voting arrangements, sale of shares, etc.) plus the annual cost of completing your year end and filing taxes.

In the US, each state has its own statutes that govern incorporating for small business. People often choose Delaware as the state of incorporation because of their management-friendly legal rulings. But where you incorporate is not the only concern about the laws that will govern your corporation.

We can't state it enough. Get proper advice. This is not the time to "do it yourself."

Moving on... once you've settled on a business structure, then you'll need to figure out how you'll fund your new business start up.

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