To some people, forming their own corporation is a sign that they really are in business. But many businesses operate just fine and never take that step. What should you do? There are many factors in the decision. Answer these seven questions to see how you stack up.
Who owns the business and how it is run
Do you share ownership, or expect to soon?
Sharing ownership of a business automatically rules out a sole proprietorship. That’s obvious. Less obvious is your choice between a partnership and a corporation.
If you are the only owner, you can’t form a partnership. That’s obvious too. Less obvious is your choice between a sole proprietorship and a corporation.
Are all the owners active, or do you have silent partners?
If all the co-owners of your business are active in decision making, you may not need the centralized management structure of a corporation. It really comes down to personal preference and how you all interact.
If some of your co-owners are “silent partners,” you might want to form a corporation to keep them that way. As shareholders, they will help elect the board of directors, which is responsible for management. This separates the active owners from the silent ones in a legally established way.
Do you have many co-owners, or plan to sell shares widely?
Imagine running General Motors as a partnership. It would be far too unwieldy. The larger the number of owners, the more important it is to adopt the only form fundamentally designed to make distributing and transferring shares easy: the corporation.
Corporations are practically mandatory for large groups of owners but become less so the smaller the group. Two partners or a sole proprietor might find little need to incorporate, depending on all the factors.
How much protection from lawsuits you need
How likely are you to be sued?
One of the main reasons businesses incorporate is to protect their owners from lawsuits. The protection isn’t foolproof, but where it works, all you stand to lose is the business, not your house, your car or your yacht.
A note investor is probably at higher risk of being sued than a note broker, because the investor is in the chain of title to the note and the broker isn’t. Unless a broker is involved in unethical or illegal transactions, the legal history suggests the likelihood of being sued is relatively small.
If you don’t see lawsuits as a significant risk, incorporation offers little benefit on this score. But you never know, and incorporation might be cheap insurance.
Will you hire employees who don’t share ownership?
Employers can be sued for the actions of their employees. Having employees favors incorporation, because the corporation is the employer, not you, and the corporation protects the owner from those lawsuits. If you don’t have employees or expect to hire any, you don’t need a corporation to protect you from this particular risk.
A corporation won’t protect you against lawsuits for your own actions. A plaintiff would be entitled to sue both you and your corporation, if you had one.
Do you trust your co-owners not to get sued?
Consider both their character and the riskiness of your business (see “How likely are you to be sued?” above). It shouldn’t have to be said, but we will: don’t go into business with people you don’t trust. Among other pitfalls, one partner can be sued for the actions of another partner.
If you don’t see this as a significant risk, the protection a corporation could give you here has little value. As always, insurance can give you additional protection.
Borrowing and personal guarantees
Does your business have enough assets to secure its loans?
When banks, suppliers and others lend your business money, they want security to make sure they will be paid back. Small businesses often lack that kind of security, so the owners are required to provide it by personally guaranteeing the loan. A guarantee overrides the shareholder protection a corporation normally provides.
Your business may have enough assets to secure any loans you need. If it doesn’t, forming a corporation would do little for you on this point.
