Starting a business is a great way to earn an income. However, before entrepreneurs start offering services or selling products, they should consider the liability that comes with going into business without incorporating first. When business owners protect themselves from the start, they are free to focus on their brand. Here’s a look at why it matters to incorporate an at-home business.
Liability in Business
Whenever anyone starts a business, it’s important to consider that without a legal formation in place they could be held liable for everything that they do within that business. It depends greatly on the type of business and the services provided, but essentially, anyone can be taken to the court over the actions of their business. Liability should be the primary concern for small business owners from the very beginning. Sometimes businesses fail, despite the owner’s best work and intentions — to the tune of 20% failing within the first year. However, with the added support of a legal formation people can ensure that their businesses do not take their personal lives and maintain a separation between the two.
Sole Proprietorship or Partnership
People might imagine formal businesses all requiring a ton of paperwork at the outset, but many people start a business without filing any paperwork at all. Plenty of businesses begin as a person who begins to offer services on the side, usually as a contractor or freelancer. They may need licenses and other certifications to provide certain kinds of products or services. Being a sole proprietor often does not call for much formal legal paperwork declaring a person’s intent to do business.
The ease of starting a business this way likely explains the popularity behind becoming a sole proprietor, as it’s an affordable entity that allows the owner to be the boss. However, this also means that as the boss you are responsible for everything that happens both good and bad. A sole proprietor may think that their business is separate from their personal life, but there is no separation between personal and professional assets. Without incorporating or forming a limited liability company (LLC), they (and their partners, where applicable) are fully liable for anything that goes wrong with the business. In a similar vein, partnerships are often formed between entrepreneurs such as family members or friends that want to share profits and losses. By incorporating as a partnership, they are able to make decisions together but are also held liable for these decisions too.
LLC or Corporation
Many entrepreneurs starting or running a small business start off by forming an LLC. An LLC is not quite like a formal corporation, because it does not create a corporate structure of taxation. This allows people to protect their personal assets and keep them separate from their professional ones, and provides tax advantages in choosing either an S corporation or C corporation as your tax entity of choice.
Corporations have a completely different structure, which is a bit more formal and allows money to be accepted from investors. C corporations, the most common type of corporation, require people to create a formal corporation and pay themselves a wage, salary, or dividends. While they are less flexible than LLCs, corporations are ideal for businesses looking to establish larger operations or raise capital from outside investment sources.
Remember that incorporating alone is not a guaranteed protection against any form of liability. Entrepreneurs will still need to provide proof that they are following state and federal business laws. They will need to apply for and maintain active permits, business licenses, and business insurance policies for themselves, employees, and place of business. This offers a layer of protection for what goes on during the business, to ensure that it can survive.
Every year, millions of people decide to become entrepreneurs and many are successful because they protected their business right from the start. By incorporating, business owners are able to separate their personal liability from that of their business, so that they can run their company without fear that failure will destroy their own financial lives.
Greg Geilman is a Los Angeles native of over 40 years and owner of South Bay Residential.