Owning a business is sufficiently risky without putting your personal nest egg and other assets on the line. You’ve worked hard to build what you have. So, it only makes sense to want to protect it. How you structure your business can be the vehicle to do just that. And, as important as protecting one’s standard of living and quality of life is, those simple letters – “Inc.” and “Corp.” – speak volumes. They carry weight in additional ways beyond practical protections from lawsuits and other actions that can threaten everything from your home to your retirement savings.
Don’t deliberate; incorporate!
As referenced, a business that is registered and structured as a “corporation” has the right and responsibility, by law, to own property, incur liabilities, sue and be sued, and satisfy debts. Creditors and their ilk can largely only seek payment from the corporation’s own assets – not from you and any other shareholders, directors, and officers. You and those partners’ homes, vehicles, and savings are generally Teflon in the face of bankruptcies and legal action. Sole proprietorships and partnerships, however, have no such “armor.” They must stare down unlimited liabilities – and both business and personal assets can be threatened.
Those three or four little letters can have a big impact on day-to-day operations. When lenders, financial institutions, or other capital sources see that your organization is incorporated, there is peace of mind. They are generally more likely to lend to corporations, rather than sole proprietorships, due to the comparatively minimal perceived risk. So, by and large, corporations have access to more and alternative sources of capital, which can be used to pay off debts quickly. Additionally, as a corporation, you have a nice sustaining lifeline in the form of issuing stocks. Similarly, suppliers, customers, peers, and other partners instantly perceive an “Inc.” or “Corp.” as credible. That perception of credibility, sustainability, and stability automatically gives you an edge, a marketing tool in disguise.
Tied to stability and sustainability, corporations can persist regardless of the ebbs and flows of each director, office, manager, or shareholder. Your brand has built-in protection from legal entanglements that can shorten its lifespan, and that can bring other types of businesses to their knees.
If, for any number of reasons, you don’t want a great big spotlight on your involvement with said corporation, owners have anonymity that is elusive as a sole proprietor or within a partnership. You can remain “silent,” free of the public bullhorn associated with other business structures.
Steps to structure
As referenced, how you structure your enterprise is not a choice to be taken lightly. It has a real effect on ongoing operations, tax liabilities, and personal liabilities in the event of legal action against your venture. It should also be noted that, while you are not locked into this structure for perpetuity, changing later could have unpleasant tax implications and result in unintended dissolution.
As a sole proprietorship, paperwork is pretty much a no-brainer. If you do business, and don’t register otherwise, you are automatically considered as such. It’s great, because you don’t have to wade through lots of paperwork. You can still get a trade name. And you are 100% in the driver’s seat. It’s not-s0-great because of the aforementioned risk to your assets and liabilities, as “business” and “personal” is one and the same. Additionally, it can be challenging to raise the capital that you need as a maturing business. You can’t sell stock, and financial institutions such as banks may be wary of lending to you. This structure can be appropriate for those in “low-risk” businesses, and those who want to “test the waters,” akin to training wheels prior to registering as a formal business entity.
As a partnership, you can register as a Limited Partnership or as a Limited Liability Partnership. As their names suggest, the LP has one general partner with unlimited liability, while the other partners have limited liability. In these situations, often the other partners also have limited control – stipulations that are documented to avoid sticky situations later on. Each and every owner in an LLP has limited liability. So, each partner is protected from debts and suits against the partnership. And they won’t be held responsible for other partners’ actions. It may be appropriate in multiple owner business situations, such as professional legal, engineering, and real estate development firms.
The Limited Liability Company (LLC) also affords protection from personal liabilities. Profits and losses pass through personal income without corporate taxes being levied; however, LLC members are “self-employed” in the eyes of the IRS, and must pay tax contributions to Medicare and Social Security. Also, when members join or exit, the LLC may need to be dissolved and re-formed. This may be a moot point if there is legal documentation to support the purchase, sale or transfer of ownership. This arrangement may be appropriate for those entrepreneurs in moderate- to high-risk businesses. It can also be more attractive than a corporation due to comparatively favorable tax rates.
The Corporation (C-Corp) also exists as a legal entity separate from its owners. The corporation profits, is taxed, and can be held liable for lawsuits, debts, and other credit and legal actions. So, this structure provides the strongest defense against a potential onslaught of judgments that could devastate your family’s assets. Unsurprisingly, costs to form, and the extent of record-keeping and reporting, is considerably higher versus other structures listed here. You may be subject to taxation twice; income tax on profits and when dividends are paid on your personal tax returns. Advantageously, the C-Corp is largely unaffected by shareholders coming and going (selling), and capital sources are ubiquitous. Capital-raising via stock is both enticing to top talent and additional partners of all kinds. Those businesses on the higher end of the risk spectrum may be appropriate candidates for this arrangement. Also, if “going public” is on your wish list, this is your path to do so.
The layers of Corps look like this:
S-Corp, which allows profits (and some losses) to be passed through owners’ personal income without being subject to corporate tax rates
B-Corp, or “benefit” corporation, a for-profit that is required to document its “public benefit” and contribution to the overall public good in its annual benefit reports
Close Corp, like a smaller B-Corp with a less formal corporate structure; may be run by small groups of shareholders (minus the Board of Directors)
Nonprofit Corp, also known as 501 (c) (3) as a nod to the tax code that stipulates tax exempt status; exemption may be on the basis of the organization’s charitable, religious, literary, scientific and educational merits, and must adhere to special rules about how the likes of profits are allocated
Owned and operated for the benefit of those who use its services, Co-ops generate profits that are then distributed among its members (user-owners). Regular members have the power to elect the Board of Directors that run the co-operative, and also control the direction of the group. Members can also have ownership stake, by buying shares.
Additionally, your organization’s business structure may fall under one designation, while its tax status may fall under another designation. Your venture is one-of-a-kind. So, even if you such a seemingly complex arrangement is not appealing to you, it is important to discuss all options with members of advisory team, such as the professionals at O’Donnell, Ficenec, Wills & Ferdig. In the meantime, the U.S. Small Business Administration provides this cheat-sheet that charts various business structures (scroll down) with “at a glance” insight into ownership, liability and tax considerations.
For more than 70 years, OFWF has proudly guided organizations in the metro area throughout the lifecycle of their ventures, including incorporation and related services. We look forward to setting your team up for future success.