To Incorporate Or Not To IncorporateSarah Calvert is the principal and founder of the law firm, Calvert and Associates, which specializes in small business legal services. Sarah has become one of my very favorite members of our Brain Trust, and not just because she isn't your typical lawyer type. She possesses what I consider to be the twin virtues of those who serve in the world of entrepreneurs: 1) She really helps small business owners, and 2) she honestly gives a damn about us.
Sarah and I conducted a series of shows on what she calls "101 Ways To Avoid Liability In Your Small Business." The first thing we talked about was the business legal structure. Two of the questions I am asked most often are, "How should I structure my company legally?," and "When should I incorporate?." Sarah likes to answer these questions, with her tongue only somewhat in her cheek, "Incorporate early and often." Which is exactly what I would expect a small business attorney to say. My opinion is a little different.
First let's understand what incorporating does for you. Simply put, by incorporating, you:
1. Create a legal entity through which you do business.
2. Establish what is commonly called a "corporate veil" which protects the owner's personal estate from any claims made against the corporation.
This corporate veil is pretty handy, but it has limitations. For example, if an employee injures someone or something while working for you, any claim would likely be filed against that individual and your company, but not against you personally, unless you were found to have personally contributed to the problem.
But if you are the only employee of your company, that negligent employee is you. So the liability insulation isn't going to protect you in this case.
Sarah's right. You probably should incorporate. But initially, unless you start out with contracts, employees, vehicles, equipment, etc., you might be able to spend that $500 to $1,000 on something more critical, like a computer, or software.
This is where Sarah would say, "Fine, Jim, but once you are up and running, growing and hiring people, you might forget to incorporate." Once again, Sarah's right. So how do I solve this problem? With triggers. Here are some for you to consider.
I think you should incorporate when:
1. You hire your first employee, especially when that employee conducts work with any degree of danger, and/or if that work is off your premises, as in a delivery or an installation. Example: If your delivery person causes an accident in one of your vehicles, any claim for damages would be against that individual and his employer, your corporation; not the shareholder of that corporation, you.
2. You enter into contracts on behalf of the business. Example: A customer feels that your company's performance has not met the contract provisions and decides to take legal action. If you are incorporated, any claim would typically be against your company, not you personally.
3. You make purchases from vendors on an open account basis, which is to say they extend credit to your company. Example: If your company has difficulty paying vendors, as long as you have not endorsed a personal guaranty to a vendor, any action they might take will be against your corporation, and not your personal estate.
4. You have $500-$1000 to spend on an attorney to get you incorporated. But, as Sarah might say, sometimes you can't afford to not be incorporated.
Sarah's right (she will like me saying that so many times). There is nothing wrong with being incorporated. My position is one of priorities.
There is at least one danger in being incorporated. Actually, it's not so much about being incorporated as it is about how you do business and manage your corporation. Here are a few of the mistakes you can make after you incorporate, and while you are assuming what might prove to be a false sense of liability security:
* You don't tell anyone, like the people you do business with, that you are incorporated;
• You don't put "Corp," "Corporation," or "Inc.," WHEREVER your company name is shown. If you are part of a holding company, like a DBA (doing business as), and don't put "a division of," or "DBA" on everything;
• You don't have a checking account in the corporation's name;
• You don't maintain proper corporate documentation, like failing to produce corporate minutes and documentation of shareholders and directors meetings, failing issue shares of stock, etc.
If you are guilty of any of these mistakes, you are at risk of having something happen called "piercing the corporate veil" (sounds painful, doesn't it?). This is when someone brings a claim against your company and they want to get to your personal assets. Their attorney will actually look into how you conduct your business. If they can determine that you are guilty of some of the things I mentioned, (there are many other examples), they will attempt to demonstrate to the court that you are not operating as a real corporation, and therefore, not entitled to the liability protection of a corporation. If successful with this strategy, they can literally "pierce your corporate veil" and get to you and your stuff. This is not an easy thing to do, unless you help them.
Write this on a rock... If you can afford it, and if the time is right, incorporate. Absolutely. But when you do, make sure you operate like a corporation, not like the sole proprietor you used to be. Think of your corporate veil as you do your roof: maintaining both will protect you from dangerous things that fall from the sky, like hail and attorneys.