When to Incorporate
Before you incorporate you should take into consideration your personal scenario, what you may consider is what you need to protect. If you have assets that are at risk, you should start there. In the eyes of a creditor, anything you own is an asset. Your home, bank accounts, investment accounts and property could be targeted to satisfy business obligations. Limiting your personal liability is a premier factor to incorporate. Incorporating also affords you a broader financial scenario where you can benefit through minimizing taxation and keep more of the money you make. This should be weighed carefully with what type of business you are involved in.
Ask yourself some questions; Will you be exposing your assets through high risk business industry, such as hazardous materials or opening the door to someone else exposing you to liability such as hiring employees? What types of business expenses will you incur after you incorporate? Does your business, or will it in the near future, own property such as vehicles or equipment? Just in the above examples you can begin to shape up benefits of incorporating.
Incorporating a Side Business
Here we will explore an example of a small business that started out as just some “side work” and what key thresholds involved lead to incorporating a business.
EXAMPLE: Mike is a full time employee of a truck suspension shop and installs kits and fabricates custom components for performance vehicles. Often times he is asked to lend his expertise for special projects, such as race trucks, building bumpers, roll cages and mounts for specialized system components. He does this on his free time working with his client’s team, using their tools and workspaces. Currently he is making a couple thousand dollars a month working weekends and during the race season spends several late nights helping out teams, providing his services. Mike thinks that he doesn’t need to incorporate yet.
Mike claims the income on his personal tax return, however doesn’t have business deductions since he is only providing services and doesn’t need equipment or tools, such as welding supplies and compressors. Mike is single and rents an apartment and has minimal personal assets. His revenue from his side projects is roughly a quarter of his full time job income. Mike’s work doesn’t expose him to a personal injury scenario or product liability, so his risk is minimal. In this case, it may be in Mike’s best interest to remain a sole proprietor and claim his side income with little or no itemized business deductions.
We can continue with this same example and show Mike’s business growing over the course of a year. Now he has purchased his own equipment, a trailer to carry it on and a truck to haul his tools. His business now owns property. In addition, Mike is making more money and considering leasing his own space so that his clients can bring him a vehicle for periods of time to undergo his fabrication work. Mike is also considering hiring an assistant part-time. This crosses a threshold where incorporating should be the next step. Mike is now increasing his business income and expenses. The space he leased where customers and delivery persons are present on a regular basis expose him to personal injury scenarios. Hiring an employee means that anything his employee does on behalf of the business, Mike is responsible for. This liability means its now time to incorporate. Now Mike is advised to formerly organize his business under an incorporated entity in order to separate his personal situation from that of his business.
Mike could have started out a sole proprietor and his growth lead to thresholds suggesting that he incorporate his business. If Mike’s business plan were to start out part time, acquire equipment and tools slowly, then find a space and take on his fabrication full-time, he may have wanted to incorporate at the inception of his business. This opens the door for additional benefits. If Mike were to lease or finance a piece of equipment, his business being incorporated for x years could be a benefit to having a business credit profile being established, further separating him from that of his business. Limiting his liability even more.
Start-Up Business Incorporation
Another example scenario is a start-up business who’s executive management has big plans for the growth and even sale of the enterprise where incorporating is in the plan from day one.
EXAMPLE: Deanna is a legal services small business owner who helps other business owners maintain their corporate formalities. She keeps corporate records, minute books and legal documents up to date for a local client base. Her business is based on paralegal services utilizing a hands-on approach where she can manage all of her clients document needs through her established business offices and employees. She decides to develop web-based software that enables her clients to provide the information to a software system that will create the legal document for them which they download. Now Deanna’s reach is global, via the Internet, and her target market now includes every incorporated business in the country.
Deanna brings outside consultants onboard to facilitate the business model and technical solution. She decides that this business has huge revenue potential and is going to seek out investors to move the company forward quickly and bring this technology to market. Working with her consultants, business modeling takes place as well as business analysis for software development. She immediately wants to incorporate the business. She is expecting to have a staff of 24 people within the first 12 months, lease office space and equipment and reimburse consultants for their expenses during the start up of this business.
This is a situation that warrants incorporating. The plans for this business and expenses necessary just to prove the business model make the cost of formally organizing the business into an incorporated entity nominal at best. This proves to investors that she is serious about success and being in the business for the future. She has invested her own personal funds and extended her personal credit to guarantee a merchant account for online transactions. She began her entire business roll out as a distinct separate entity from herself since she did incorporate right away, therefore her personal assets are not exposed to business liability and obligations – with the exception of a personal guarantee for a merchant account, however we will discuss these topics later in the guide.
Incorporate for Major Liability Protection
In some cases, it would be ridiculous not to be incorporated before anything else. In the next example, and the shortest one, incorporating is absolutely necessary.
EXAMPLE: Jim is a plastic surgeon, opening his own practice. This profession opens him up to malpractice suits, product liability (in some cases) and a myriad of exposure to having his assets targeted by a creditor who was awarded a judgement that was in excess of that of his insurance policy. Even a well insured, experienced, professional cannot escape the liability storm in a field such as this. Here Jim incorporates a Professional Corporation to open his new practice.
None of these examples were similar in nature, however it does demonstrate the same decision making process when considering incorporation. First off we had an individual who was making some extra money while employed full-time, where his business grew passed thresholds that demanded liability protection where incorporation was the next step. In the second example we had an entrepreneur who was exposed to no liability [yet] and decided to incorporate for legal separation, credibility and to support her future goals of growing a successful business through venture capital. In the final example we explore a situation where incorporation was simply required. Three very different situations, however they all brushed up against the factors for incorporating a business, liability protection, minimizing taxation, credibility, attracting investor capital, etc.