If you’re the owner of a small business, the question of whether or not to incorporate has probably occurred to you. Most small businesses start out as sole proprietorships or partnerships, and there’s no reason you can’t maintain that business structure indefinitely. In fact, over 85 percent of small businesses without employees are sole proprietorships, the Small Business Administration reports.
Nonetheless, changing the structure of your business may have some benefits that you haven’t thought about. What’s more, you don’t always have to go through the formalities of incorporating to realize them. Learn your options and get some tips about the best way to structure your business below.
Know Your Options
Before you decide whether to restructure your business, know what your options are. In general, these can be broken down into three main categories: sole proprietorship; corporation; and limited liability company or LLC.
- Sole proprietorship: If you are the sole owner of your business, you are already a sole proprietor. Other than obtaining a business license, there’s no paperwork and no other legalities involved. You report your business income on your personal income tax returns.
- Limited Liability Company: A limited liability company is essentially a scaled-back version of a corporation. Forming an LLC is relatively simple, and ensures that your personal assets are protected in the event your company goes bankrupt or is on the losing end of a lawsuit. As with a sole proprietorship or partnership you and all other owners report your business income on your personal income tax return.
- Corporation: Two types of corporations exist in the United States: C corporations and S corporations. Like an LLC, an S corporation is a “pass-through entity.” This means the business’ profits and losses are “passed through” to the owners and reported on their personal tax returns. C corporations are more formal entities and must pay corporate income tax. Few small businesses choose to incorporate in this way.
Now that you know the options, let’s look at the potential benefits.
Separation of Personal and Business Assets
The main benefit of either an LLC or a corporation is shielding your personal assets in the event you sustain a business loss. However, because the members of an LLC are more involved in the day to day operations of the business, the courts are more likely to hold them personally liable for serious misconduct or willful bad acts.
If your business is growing and you need capital to expand, you can add another member to an LLC. In other words, you can sell a portion of your business to another partner to get the funding you need. Similarly, if you incorporate your business you can raise money by selling shares of stock to private investors.
Recruitment and Retention
If you incorporate your business, you can offer stock options to your employees. This gives your company an edge when it comes to attracting talent in a competitive marketplace.
Do you have dreams of taking your business public someday? If you want to sell stock to the public (as opposed to a few early investors and venture capitalists) you must first incorporate, form a board of directors and meet the regulatory requirements of the SEC.
Obviously, making the decision to incorporate or form an LLC isn’t one you should make lightly. You may wish to speak with an attorney before taking the plunge. Once you’ve made a choice, however, you’ll be glad to know that handling the formalities is easier and less expensive than ever. Just go online and choose an option like LegalZoom, MyCorporation or incorporate.com