Deciding which type of business entity your new venture should be isn’t the most romantic or exciting part of small business entrepreneurship. In fact, it can be quite dry and arcane.
But this step is crucial because it establishes an important legal foundation for your business for years to come. Most businesses setup as a corporation (known as “incorporation”), but whether or not this is the right direction for your business depends on your individual situation.
Let’s take a look at the pros and cons of business incorporation.
Pros of business incorporation
1. Legal protection
Legal protection is one of the biggest reasons why many business owners choose the path of incorporation. By incorporating, you are able to separate your personal assets from your business ones, and thereby protect yourself from being sued as an individual. Only the corporation is subject to a lawsuit.
One important caveat applies here that is applicable for one-person businesses just getting off the ground: your business must function as a separate entity in order to be a corporation. If you do consulting work out of a home office and there is no clear distinction between your business bank accounts and your personal bank accounts, then you would not qualify. The state is unlikely to investigate this that closely when you fill out the paperwork, but a future unhappy client might and charge you with fraud.
We aren’t talking about credibility with potential customers (although that would be another ancillary benefit). We’re talking about attractiveness to investors. Incorporation allows you to issue stock and payout dividends. The formal business structure required by a corporation gives your venture the stability that investors like to see.
Cons to incorporating your business
1. Paperwork & fees
You will have to pay a fee to the state to incorporate your business, and you’ll need to spend some time filling out paperwork. That can seem like time and money you don’t have at this stage of your business life.
2. Regulatory requirements
That business structure that investors like to see doesn’t come without jumping through some regulatory and legal hoops. In order to maintain your corporate status, most states require you to hold regular meetings with the directors and maintain records of meeting minutes. You will also need to maintain records of activity, which can be used to establish separation of the business from your personal life.
Taxation: advantages and disadvantages
We’re listing this as a category unto itself because determining whether it’s a pro or con depends on a number of factors. Foremost among those factors is what type of corporation—S Corp or C Corp—you end up choosing.
Do you plan to cut yourself a salary that’s separate from the profits of the business?
If so, you’ll want to avoid double taxation. A corporate structure can help you do that.
On the flip side, your corporate structure can work against the very investors you are trying to attract. Income is taxed when it comes to the corporation, thereby reducing the profits you ultimately take home. And then investors have to also pay taxes on the dividends they do receive.
If you’re still unsure whether you should incorporate or not, consider consulting a business attorney to determine whether incorporation is best for you — and if so, which particular form to choose.