Every entrepreneur dreams of the day his or her fledgling startup becomes a going concern, but you could end up losing everything — including your house and your car — unless you take steps to separate and protect your personal assets.
“Owners should have limited liability for business debts and obligations,” says François G. Laugier, partner and director for Ropers Majeski Kohn & Bentley PC. “Incorporating sooner rather than later offers considerable protection with virtually no downside.”
Smart Business spoke with Laugier about the benefits of incorporating at the right time.
When is the right time to incorporate?
Owners expose themselves to liability for their company’s actions and debts the minute their venture becomes operational or starts hiring employees. So, it’s time to incorporate when your startup begins interacting with third parties or logs its first sale. Whether you manufacture food products or develop software, you could lose everything unless you form a legal business structure to safeguard your personal assets.
What are the advantages of incorporation?
Incorporating not only keeps creditors from attacking your own assets and employees from suing you personally, but it also increases a company’s credibility and raises the valuation you can expect to receive from a prospective acquirer. A corporation is always perceived as a safe and familiar recipient where a business can accumulate intellectual property and other assets such as patents, trademarks and copyrights to subsequently transfer them to a new owner or heir. And consumers, vendors and partners often prefer doing business with an incorporated company. Incorporated businesses can also offer stock options to employees and contractors, thereby attracting the best technical talent and, in turn, the most influential investors. And, history shows that buyers are willing to pay more for a business that is incorporated, has a well-maintained corporate book, complete with up-to-date annual records and government filings, and that has received guidance from reputable and competent lawyers, accountants and advisers.
What are the different legal vehicles available for incorporation?
Entrepreneurs of for-profit ventures usually consider a limited liability company (LLC) or a corporation when selecting a legal entity. For budding companies, a LLC is often the preferred choice because its shareholders, called members, only pay taxes on profit distributions at the member’s personal income tax level, while profits are otherwise taxed at both the corporate and personal level when generated through the activities of a corporation. For the IRS, a LLC is known as a ‘disregarded entity,’ as its profits and losses essentially pass-through to the owners. But if you soon plan to raise venture capital or offer employees stock options, a corporation is the better vehicle. Get advice from your lawyers and accountants, but remember the conversion of a LLC into a corporation is a relatively simple legal process. Conversely, there will be a host of negative tax consequences if you convert a corporation into a LLC.
How can business owners limit their personal liability by incorporating?
If your budget is so tight that you can’t hire a lawyer, it’s tempting to incorporate on the Internet, but the lack of a formal business structure and legal guidance can leave you just as exposed as if you had not incorporated. To limit liability, you must ensure your company is sufficiently capitalized, has complied with securities regulations when issuing shares and soliciting investment, and you haven’t commingled personal and company funds. You must also record the proper documents on the federal, state and local levels and maintain a good record of all accounting transactions, meeting minutes and periodic filings so savvy creditors can’t attack your assets by piercing the corporate veil.
When shouldn’t a business incorporate?
It may not make sense for an independent consultant or a very small business to go through the incorporation process. Their limited exposure may not require the protection and cost of a corporate entity. But for everyone else, there’s no reason to link your personal assets to the company’s fate.
François G. Laugier is a partner and director at Ropers Majeski Kohn & Bentley PC. Reach him at (650) 780-1691 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Ropers Majeski Kohn & Bentley PC