A word to the wise: if you sign a document prior to incorporation, you may still be personally liable for that specific agreement. So, incorporate sooner rather than later once profits are progressing. ~ Allan M. Siegel, Partner and Attorney, Chaikin, Sherman, Cammarata Siegel, P.C.
From wanting to smooth over ownership issues to paying attention to your profits, here are seven answers to the question, “Can you share some telltale signs that it is time for a business to incorporate?”
- Needing an Easier Ownership Transfer
- Outgrowing Its Current Operations
- Getting Too Big for an LLC
- Reaching a Higher Level of Stability
- Protecting Yourself Legally
- Hiring Employees
- Increasing Profits
Needing an Easier Ownership Transfer
In my view, incorporating a business makes it simpler to transfer control of the company, whether that happens through the sale of the company or through succession planning. This is because businesses have distinct ownership structures and transferable stock, both of which simplify changing ownership and assure a seamless transition.
Outgrowing Its Current Operations
A business should incorporate when it outgrows its current structure and needs to formalize its operations. Incorporating can help to streamline processes and make the business more efficient. It can also help to protect the owners from personal liability, which is particularly important as the business grows and takes on more risk.
Therefore, one telltale sign that a business should incorporate is when it is generating consistent profits and is growing beyond just a one-person operation. By incorporating, a small business or a startup could create a more efficient system for managing clients and projects and could attract new clients and investment by demonstrating that it is a stable and well-structured business.
Getting Too Big for an LLC
Many entrepreneurs launch their businesses under a Limited Liability Company (LLC) structure because of its ease of operation, flexibility, and liability protection. However, growing an LLC beyond a certain size can be challenging because of restrictions on new investments.
Operating agreements, regulations, and capital raise restrictions may limit LLCs. While Incorporating brings reporting requirements, it allows a business to easily transfer ownership through shares.
One telltale sign that a business needs to incorporate is when it needs to raise substantial sums from many investors to take the business to the next level.
Reaching a Higher Level of Stability
A business may consider incorporating when it has reached a level of stability and profitability and is ready to separate its finances and legal liabilities from its owners.
Incorporation can offer several benefits, including limited liability protection, tax advantages, and credibility with customers and partners. One telltale sign that a business is ready to incorporate is when it is generating consistent profits and has a coherent plan for growth.
Incorporation involves significant legal and financial responsibilities, and a business should have a strong foundation and the resources to support these responsibilities before taking this step. Additionally, if a business is facing potential legal issues or liabilities, such as lawsuits or debts, incorporation can help protect its owners from personal financial responsibility.
Protecting Yourself Legally
When you’re operating as a sole proprietor, it does not protect your personal assets from lawsuits related to your business. If you’re sued, then your personal savings and investments could be at risk.
By incorporating, you protect yourself from all these risks. It means that your company will now become a legal entity separate from yourself, so any liabilities are limited solely to the corporation’s assets. This is especially important if you plan to work with other investments in the future.
I think a business should incorporate when they hire employees. A solo entrepreneur who is running their own company, even if they are working with contractors and freelancers, is fine. But a company should incorporate as soon as they pay actual employees and begin adding to their company like this.
It makes things easier for tax season, and employees can be comforted because they are working for an incorporated company. Bottom line: As soon as a company adds actual employees to part-time or full-time positions, they should incorporate.
You should incorporate if your profits are increasing. If your business begins as a side hustle or sole proprietorship, any money you make is classified as personal income and taxed as such.
However, once profits exceed a certain sum, it is often preferable to have them assessed at the corporate rate. Depending on your financial decisions, this could considerably lower your tax bill. As profits increase, so do expectations, responsibilities, and risks.
Forming a corporation at this point can help to protect your assets, by separating personal and professional liability. Growth in profit often precipitates change, perhaps expanding the business, diversifying offerings, or employing staff. Incorporating can ensure that you are legally protected while undertaking these ventures.
A word to the wise: if you sign a document prior to incorporation, you may still be personally liable for that specific agreement. So, incorporate sooner rather than later once profits are progressing.