So you’re ready to start up your new business in San Diego but are still wrestling with the idea of incorporating or forming an LLC (Limited Liability Company) instead of operating as a sole proprietor? Young entrepreneurs should be cautious. There is a misconception that a Corporation or LLC is always the right choice for new business. Law firms and attorneys and even do-it-yourself legal services sing the praises of incorporation and routinely dismiss the sole proprietorship. After all, small businesses do not need lawyers to obtain a business license. In reality, operating as a sole proprietorship may still be the right decision for many start-ups. When starting a new business, all forms of business should be considered including the sole proprietorship.
There are two key factors that influence the business formation decision – minimizing taxes and limiting personal liability. In most cases, particularly in the small business context, tax savings from incorporation are negligible or non-existent. While corporate tax rates might be lower than personal tax rates, small business owners still have to pay income tax on dividends and the salary earned as an employee of the corporation. If taxes were the only benefit to incorporation, the hassle, expense and time necessary for incorporation would hardly seem worth it. Individuals starting up a new business often find themselves bogged down with corporate formalities instead of focusing on the business at hand.
Limiting personal liability is an issue no doubt of great importance to new business owners. There are two prongs to the liability issue:
company debt and company liability to third parties. While Corporations and LLCs offer some insulation from liability, small business owners need to consider practical considerations specific to their business. For instance, it may be difficult for a new start-up Corporation or LLC to obtain any sort of considerable capital financing without a personal guarantee. Lending institutions are savvy enough to understand the increased risk attached to a start-up company, and in today’s banking climate are less apt to look past that risk. If you are personally guaranteeing the capital financing, a Corporation or LLC
will not insulate you from that debt. Likewise, a small business’s risk of liability to third parties (being sued) depends on the type of risk associated with the business. A construction company might be more concerned about this prong of liability than perhaps a new internet fashion blogger. Moreover, professionals like attorneys or dentists cannot expect to insulate themselves from malpractice simply by incorporating. Malpractice insurance for professionals is a must.
New businesses of all types have the option of insuring their company and should. With adequate insurance, the need for corporate insulation diminishes.
There are other considerations. For instance, it is legitimate to assume that business names like Company, Inc. and Company, LLC carry more credibility. How much and how helpful this is to a new start-up really depends on the specific business. Group health insurance plan rates which may offer some advantages over individual plans are available to Corporations or LLCs. Again, this is a consideration specific to the young entrepreneur. Whatever the considerations, new small business owners shouldn’t automatically assume that a sole proprietorship is somehow inferior to a forming a Corporation or LLC. Analyzing your business needs, consulting an accountant and doing some basic research will often be all you need to decide that a sole proprietorship is right for your business. As your business grows, you can always revisit your business entity options.