Starting a business involves a lot of decisions, one of which is when to incorporate and form a legal entity. Do you wait until you start making real money? When should a small business incorporate?
“Right away,” encourages small business attorney Garrett Sutton. He’s seen firsthand the problems that can arise when small business owners don’t take that crucial step. Nav Founder and Chief Legal Officer Caton Hanson agrees. He’s started several businesses, he says, Once a business gets past the idea stage he sets up a legal entity (typically an LLC). “I always incorporate my businesses first thing. I’ve done it as soon as I have decided to do any kind of business.”
Here are three reasons to incorporate your business sooner rather than later.
You’ll Help Protect Your Personal Finances
Sutton’s primary reason for recommending incorporation is that it can remove personal liability from the equation. “People will say, ‘I’ll wait until I’m making enough money,’ but you’re personally responsible even before you are incorporated,” he warns. “You can’t afford not to incorporate.” Be aware that corporate formalities must be followed in order to maintain these protections. And while incorporating can shield you from personal liability, some lenders may still require owners sign personal guarantees when borrowing for their businesses.
Your Business Will Be Taken More Seriously
Recently I’ve been trying to find a cleaning service for my mother-in-law who lives in another state. As part of my research, I’ve immediately eliminated cleaning services that haven’t formed a legal entity. To me that indicates they are not serious about their business. The job I am trying to hire for is a small one, though: imagine if these cleaning services wanted to land commercial cleaning jobs or even government contracts. Operating as a sole proprietor may not cut it.
Hanson says he often researches prospective business partners, vendors and clients. Those that have not incorporated their businesses give him pause. “It gives you a perception that maybe they don’t have things buttoned up and maybe are flying by the seat of their pants,” he says, adding “The bigger the vendor the more important it is.”
It Will Be Easier to Build (And Use) Business Credit
You can build business credit as a sole proprietor but it’s not as effective as if you have incorporated. Filing a corporation with your state often puts your business information on the radar of commercial credit agencies. It also allows you to get away (eventually) from risky personal guarantees. It’s much easier to build business credit when you have formed a legal entity. Building the entity isn’t the last step, you’ll want to keep an eye on your business credit score throughout the life of your business (you can check it for free with Nav.)
When you do get to the point where you want financing, some lenders will require you to provide bank statements from a business bank account. To open a bank account in the name of the business, it is helpful to be able to show that you have the legal right to use the name. Some financial institutions will want to see your articles of incorporation.
Incorporating your business doesn’t have to be difficult or expensive, says Hanson. Resources like Sutton’s book, Start Your Own Corporation, can help you understand and evaluate your options.
For many small businesses, the cost will be anywhere from $100 to $2500 (or more, in certain situations) depending on filing fees in your state and whether you choose to do it yourself, get limited help, or hire an attorney to do it for you. Still it’s a relatively small investment in the future of your business, says Hanson, adding that it may be a “good indicator of whether you are serious or not.”