There are so many choices to make when starting up a new small business and one of the most essential is the legal status of your business. While most small businesses choose to use the sole-proprietor title others chose S Corp, C Corp, or LLC. All types of Corporations provide a degree of legal protection to their owners.
The main difference between the differing types of corporation is the way that taxes are paid. I will examine the different corporation choices in another blog article. In this article I will examine the differences between the simplest of corporations, Limited Liability Corporations, and the Sole-Proprietorship.
The first major reason most business owners choose to incorporate is to reduce the legal responsibilities of the owners. In a sole proprietorship, the individual owner and the company are one in the same. This means that if someone sues the business, then the personal assets of the owner, car, home, etc., are fair game in any judgment against the company.
On the other hand, if your company is organized as an LLC, the company is a separate entity from the owner. If a person sues the company, only the assets of the company can be used to pay any legal judgment. The personal assets of the owner are safe unless the owner is not found to be personal negligent for the losses.
Most new businesses require some type of capital to get started. Because a sole proprietorship is founded on the name of the person who owns the company, any credit and debt is the sole responsibility of that person. If the business fails and loans cannot be repaid, the owner of the company is completely liable for that bad debt. With an LLC, the business is a separate entity from the owner. This means that if the business should fail, in most cases, the debt would not be the sole responsibility of the owner.
In addition, how a business applies for credit and financing differs with each business entity. With a sole proprietorship, the credit history of the owner is the only basis in determining whether the business is a good credit risk. If the owner has bad credit, getting the business financed is going to be much more difficult.
When the business is incorporated banks can also look into the credit history of the corporation. This may not help obtain funding for start-up costs but it will impact credit decisions after the LLC has been established for a period of time.
One of the major reasons business owners choose not to incorporate is the paperwork involved. The paperwork involved in becoming an LLC is not as onerous as the legal requirements for some other business types, but an Article of Organization and the Operating Agreement will need to be drawn up. While these articles can be drawn up without outside help; legal assistance is always recommended. Some states will have additional fees and specific requirements for LLCs that will need to be adhered too.
The deciding to begin a new small business is a major life-changing experience and each smaller decision will impact the health of your new business. This decision should be based on the size and complexity of the business and how many owners, shareholders, or members the business will have. While a LLC take more time and effort to establish it may become the difference in staying in business for two years or twenty.