So your small business is thriving. You’ve doubled your number of employees in one year, you’ve opened up three new brick-and-mortar locations and your online store is doing better than ever. You’re ready to take things to the next level, and now you find yourself asking that all-important question – to incorporate or not to incorporate?
Incorporating a business can be a good idea for some entrepreneurs, but it certainly has its drawbacks as well. Consequently, it’s important that every business owner weigh the pros and cons of creating a corporation before they decide to take the plunge. To help you out, here’s a rundown of the advantages and consequences of incorporating your small business.
- Incorporating protects owners from liability. When you incorporate a business, it creates a legal entity that is separate from the owners of the corporation. As a result, owners cannot be held responsible for a corporation’s debts and obligations. This means, among other things, that you cannot be personally held liable if someone decides to sue your company.
- It makes diversifying ownership easy. If you founded your business with multiple partners, incorporation is often a good idea because it converts ownership interest into tangible shares of stock. This stock can be easily sold or transferred to whomever the shareholders see fit. Conversely, to change ownership of a partnership or proprietorship you would have to retitle property, draw new deeds and fill out a litany of paperwork. Kind of a pain, right?
- Incorporating facilitates growth. Incorporation is also useful if you plan on growing your company. With your company divided into shares, you can easily attract new investors and raise capital through the sale of stock. Should you eventually decide to go public, incorporation will make the transition easy.
- The paperwork. One of the biggest pitfalls of incorporating your business is the paperwork. After filling out articles of incorporation with your state, you have to document any and all activities and transactions made by your new corporation – including management conferences, shareholder meetings, board meetings and anything else.
- Taxes get more complicated. It’s true that a corporation can claim more tax deductions than a proprietorship, but to do so it must go through a complicated tax process that requires periodic filing with a number of associated fees. The most troublesome aspect of this involves filing income taxes for the corporation. While not an issue for larger corporations, income filing means that smaller corporations with only one owner will be taxed twice – once at the corporate level and again on the owner’s personal return.
- They’re expensive to set up. Forming a corporation isn’t cheap. The annual fees you need to pay on a state and federal level far exceed those levied on proprietorships or partnerships. Additionally, due to the complexity of maintaining a corporation, owners often have to retain a lawyer and an accountant in order to ensure that the company remains above board on all state and federal regulations.
So Is Incorporating Right for You?
At the end of the day, incorporation should be viewed as a way to push your company to the next level – not to get it off the ground. If your company is ready to start selling securities and raising capital to expand, then incorporating is probably a smart move. If you’re still bootstrapping a startup, though, then the cost of incorporation will probably outweigh the benefits.
So if you’re thinking about incorporating your company, weigh these pros and cons carefully. Do your research on how to incorporate a business and then make an informed decision based on your long-term business plan.