The Business and Legal Considerations of Incorporating Your Business

5 Things to Think About When Incorporating Your Business

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Business considerations play a crucial role in deciding which form of organization is best for your enterprise. Balance the tax benefits of incorporating with various business and legal needs.

Ability to Raise Capital

If your new venture has a pressing need to raise capital from outside investors, forming a C-corporation is likely the easiest way to satisfy the demands of investors. C-Corporations can have an unlimited number of shareholders, can have different classes of stock, and do not need to be dissolved if a shareholder leaves.

Partnerships, by contrast, must terminate whenever more than 50% of the partnership interest changes hands. Raising capital in a partnership is consequently more involved. S-Corporations are limited to 100 shareholders, which can sometimes limit the ability of an S-corporation to raise capital. Schedule C sole proprietors are limited to only one owner, so sole proprietors have no ability to raise capital from outside investors.

Ability to Transfer Ownership

At some point in time, you may need to transfer ownership of a business to someone else. You could be selling your business, transferring some of the ownership to your children, or bringing in a new business partner. With C-corporations and S-corporations you can add new shareholders and transfer shares with relative ease. Transferring a significant portion of a partnership, by contrast, may require that the partnership terminate and a new partnership be formed.

Finally, sole proprietors cannot transfer ownership of their business. If they want out, they can sell all the assets and liabilities of the business to someone else, but the buyer would have to form his own business.

Separation of Ownership & Management

In Corporations, Limited Liability Companies, and Limited Partnerships, owners are separate from management.

Owners do not necessarily take on any management responsibilities, and managers do not necessarily shoulder any ownership responsibilities. This separation is crucial for keeping liabilities from bad management decisions from depleting the shareholder's personal assets. By contrast, general partners in a partnership and sole proprietors are not separate from management. They actively engage in management decisions and daily business activities and might become responsible for the consequences of management decisions.

Limited Liability Protection

The major legal consideration in choosing a form of business is limited liability protection. Limited liability means the owners of the business are only liable for the capital they have invested. Let's say my company is sued for $1 million, but as a shareholder, I have invested only $10,000. With limited liability, the most I can lose is the $10,000 I have invested. My personal assets (house, car, bank account) cannot be touched. Limited liability is available for C-corporations, S-corporations, Limited Liability Companies, and limited partners in a Limited Partnership or Limited Liability Partnership.

General partners in a partnership and sole proprietors, however, have unlimited liability.

Creditors and lawsuits can go after the owner's personal assets (real estate, bank accounts, etc.). As such, general partnerships and sole proprietorships are appropriate for businesses with small risk for liability exposure. If you are at risk of being sued for accidents, bad decisions, or property damage, you should consider whether the limited liability features of different business entities offer the level protection you desire.

Ease of Incorporation

Setting up a sole proprietor business is the easiest thing to do. You actually don't need to do anything until you file your first business tax return on your Schedule C. This is also the easiest business to shut down – you just stop being in business. All the other forms of organization, however, require filing various papers with your state government and with the Internal Revenue Service.

To incorporate your business, you will need to write up your Articles of Incorporation, By-Laws, file various documents with your state government, obtain an Employer Identification Number from the IRS, and once approved, submit these documents to your bank to set up a business bank account.

You can incorporate a business yourself, or you can hire a professional incorporation service. You may also need the services of an attorney. State governments charge filing fees for processing your incorporation documents. Fees vary by state and can vary by the type of organization you want to form. You may need to register a fictitious business name with your county government, and this requires a filing fee and newspaper costs for announcing your business name to the public. These fees can quickly add up, so have solid reasons for incorporating, and understand how your form of organization will achieve your business, legal, and tax needs.

Resources for Choosing How to Incorporate Your Business

Overview of the Types of Business Entities
Tax Treatment of Various Business Organizations