If you start your own business, you're going to find yourself faced with a lot of questions. Who are your customers? What's your unique value proposition? What type of structure would be best? And should you incorporate?
Incorporation is the act of establishing your business as a corporation, of which there are two types: a C corporation and an S corporation. Both offer advantages, and depending on your business might be the best option for you. But there are downsides, too, which is why you need to thoroughly evaluate your business's situation before you incorporate.
Traits of a Corporation
The primary distinction of a corporation is that it becomes a legally separate entity from its owners. Corporations also offer investment opportunities through the sale of stock, and asset protection for the business owners — in the case of risk and liability, the responsibility falls to the corporation rather than to the individuals behind it.
A C corporation is what you may think of as a "big" corporation, with potential for unlimited growth. Unlimited shares of stock can be sold, and while the corporation pays its own taxes alongside the owners ("double taxation"), tax rates can be lowered by splitting profit and loss between the owners and the business. The drawbacks include strict regulations for annual meetings, frequent tax filing, and lots of paperwork.
An S corporation eliminates double taxation, allowing owners to report business profit and loss on their personal tax returns. You could think of an S corporation as a "smaller" corporation — stock can still be sold, but the number of shares are limited. An S corporation is still required to hold annual meetings and keep detailed records, much like a C corporation. However, an S corporation requires much less paperwork than a C corporation, and taxes are filed annually.
Both types of corporation provide benefits to your business aside from investment opportunity, such as increased credibility, brand protection, liability protection, and an unlimited lifespan beyond that of the owners.
When is it Necessary to Incorporate?
When you're starting a business, you may think you have to incorporate immediately, but it's better not to do so until your situation warrants it. Incorporation comes with fees and lots of hard work to meet the legal requirements, which could overwhelm a new business. Generally, you don't need to incorporate until your business meets one of these criteria:
- Your business owns assets, like equipment, an office, or company vehicle (as opposed to using your personal tools or other possessions for business purposes).
- Your business is taking on risks that expose you to liability, such as hiring employees.
- Your business plan includes a roadmap for quick growth and the attraction of investors through stock shares.
This article by Companies Incorporated provides some examples of businesses incorporating at different times and for different reasons.
So, is it Time to Incorporate?
Ultimately, the choice is yours as to whether you incorporate your business and when, but it's a big decision you should handle carefully. Consider your daily operations and compare your business's needs with the pros and cons of incorporation. Another option for protecting yourself from liability is to form a Limited Liability Company (LLC), which will protect your personal assets in a way that might be better for your business structure.
For more information, we go into detail in our free How to Start Your Own Business ebook, which you can download for free below. Hopefully you'll find yourself much more educated on the process of starting (and potentially incorporating) your business!