3 Reasons to Incorporate Instead of Forming a Partnership or Sole Proprietorship

3 Reasons to Incorporate Instead of Forming a Partnership or Sole Proprietorship

When you’re getting your business off the ground, there are a lot of big decisions to make early-on. One of them is to choose a business structure. Knowing what structure will help you work best with investors and protect your business (and yourself) can be overwhelming.

There are a lot of options to choose from, like a Sole Proprietorship, a General Partnership, an LLC, or even a corporation. At first glance, a Sole Proprietorship or General Partnership seem the most attractive because they’re easy to set up and run with a minimum of paperwork and oversight. An LLC or corporation feels like overkill with bylaws, member voting, and stock agreements. The simpler the structure, the fewer headaches, right?

Unfortunately, “simpler” doesn’t always mean “better.” Choosing a sole proprietorship or general partnership could throw a wrench in all your carefully executed plans. We’ve laid out three key distinctions that most people overlook when they choose a sole proprietorship or general partnership:

1. Limited ability to raise capital

With Sole Proprietorships and General Partnerships, there is no formal mechanism for you to sell shares of your company. With a sole proprietorship, you will have to rely mostly on loans to raise capital, which can complicate your cash flow and put you at risk of defaulting. A general partnership also lacks a formal legal mechanism to sell shares of the business, leading partnerships to enter into debt financing agreements that can quickly become complex and risk default.

If you think you would ever want to bring your company public, you would have to change your structure. It makes more sense to chose a different kind of structure that already has that flexibility built into it, so you don’t have to change it when you’re further along and need to be attracting and making deals with investors.

2. Personal exposure to liability

Sole Proprietorships and General Partnerships are not viewed as legally separate from their owners, meaning that your assets are on the line for all the business’s liabilities. If your product makes a customer sick, they can secure a judgment against your assets. Your actions can also expose your business to liability, even if you weren’t acting as a representative of your company when you did something wrong. 

Additionally, your assets are vulnerable to liability you didn’t personally create. If your business defaults on a loan (see above), the lender can come after your assets. If your partner was the one who rear-ended someone during a delivery, your assets are at risk. It doesn’t matter if you don’t have impressive assets now. A judgment can garnish your earnings, seize chunks of any inheritances, and snatch assets for years to come.

3. Insurance doesn’t cover everything

Liability insurance for businesses cannot resolve all your liability concerns. First, insurance companies are notorious for refusing to pay out claims for arbitrary reasons. Liability insurance is no different. Additionally, insurance policies, even large ones, may not adequately protect you against sizable judgments and attorneys’ fees.

You may not have the right kind of liability insurance for the claim against your business. You must consider policies like workers’ compensation and automobile liability alongside a general policy. All of those policies add up, leaving you with astronomical premiums.

With an LLC or corporation, you have power and flexibility to manage your business effectively. An LLC insulates its owners from business’s liabilities, while a corporation is a separate legal entity, negating both your exposure and limiting your need for liability insurance. Both structures also offer structured, straightforward ways to sell stakes in the business and raise the kind of money that stimulates and sustains growth. Even if you don’t want to sell shares presently, the option is there.

LLCs and corporations serve you as both a business owner and a private individual. What other concerns do you have about choosing a business structure? How is your chosen structure working for you?  Schedule a consultation appointment with us to discuss your needs further and run your ideas past us.

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