To Incorporate or Not to Incorporate…that is the question

incorporateTo Incorporate or Not to Incorporate…that is the question

by Gina Bongiovi

I often meet with sole proprietors who wonder whether it’s in their best interest to incorporate.  99.9% of the time, my answer is a resounding “YES!”  Of course, my clients want to know why, so here goes:

To clarify, when I say “incorporate,” I don’t necessarily mean forming a corporation.  The term “incorporate” refers to the process of forming an entity so that you’re no longer operating as a sole proprietor.  You have several entity choices – corporation, limited liability company (LLC), professional limited liability company (PLLC), limited partnership, (LP), limited liability partnership (LLP), limited liability limited partnership (LLLP) and any other entities states can come up with that overuse the letter “L.”  I mostly deal with the corporation and the LLC, so for simplicity’s sake will address only those two in this article.

For any entity, you start the formation process by filling out and filing Articles with the state.  Most Secretary of State offices administer entity formations, but some states have separate corporations divisions that handle the filings.  For a corporation, you’ll usually file “Articles of Incorporation.”  For an LLC, the document is usually called “Articles of Organization.”  The second step is usually the Initial List of Officers (for a corporation) or Members (for an LLC).  This document lists the names and addresses of all the business owners.  You’ll also need a registered agent (some states call it a resident agent).  This is a physical address, not a PO box, at which a human being can accept service of a lawsuit during normal business hours.  You can act as your own, hire a commercial registered agent service, or have a law firm do it.  Many people prefer to have a law firm in this capacity so a lawsuit can be acted upon immediately.  Acting as your own registered agent doesn’t mean you have to stay at that address Monday through Friday, 9-5; it just means someone looking to sue you needs to be able to find you.  You’ll have to renew your entity every year to keep it in good standing, which involves filing an Annual List of Officers/Members and paying the associated filing fees.

If all this sounds like a giant pain in the neck, let me explain why you want to incorporate.  Operating your business through a separate entity places a “corporate veil” between your personal assets and your business, which is the likely target of a lawsuit.  In other words, if someone sues your business and wins, they get a judgment that’s usually some amount of money.  In order to get this judgment satisfied, they will look to your assets.  If you are operating your business as a separate entity, the lawsuit winner can only satisfy that judgment out of business assets; they can’t touch your personal assets.  This assumes you’re really operating the business as a separate entity and haven’t signed any personal guarantees.  In contrast, if you are operating as a sole proprietor and someone sues you, you have no entity to protect your personal assets and the lawsuit winner can satisfy the judgment out of your personal checking account, your home, your car, etc.

In only incredibly rare instances do I ever tell someone they are better off as a sole proprietor, and even then, I do so reluctantly.  In nearly all cases, it’s worth the few hundred dollars a year to maintain an entity and provide yourself protection and peace of mind.  If the few hundred dollars a year is cost prohibitive, then you probably aren’t making enough money for someone to sue you.  (Ouch, right?)  The saying goes, you can’t squeeze blood from a turnip.  So if you want to remain a turnip, then maybe sole proprietorship is okay.  But if you have aspirations to being more than a turnip, strongly consider forming an entity to give yourself that protection.  My analogies are quickly disintegrating so I’ll wrap up.

There is a misnomer out there that a corporation provides more liability protection than an LLC.  You’d have to check your own state statutes, but in most states, the individual owners of an entity are not personally liable for the debts or obligations of the business, provided the business is managed properly.  In deciding between a corporation or an LLC, you must consider the type of business you have, how you’ll fund it, how you’ll grow it, how you’ll manage it, and your exit strategy.  Yes, it’s counter-intuitive to consider your exit strategy when forming a business, but it plays a role in which entity you choose.  As an aside, these are questions that require some introspection, analysis, and a modicum of intelligence, none of which are provided by the robots over at LegalZoom.  Just sayin’.

To conclude, in 99.9% of instances, it’s best to incorporate.  The question then becomes what type of entity to form and then how to manage it so that you keep that corporate veil securely in place.

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