Deciding whether to form a business entity (LLC, S-Corp, C-Corp etc) or operate as a sole proprietor is a question often asked by business owners. While many business owners address this issue during their startup phase, there are some mature businesses who decide to form an entity after operating as sole proprietors for years. Here are a few reasons why some business owners decide that entity formation is in their best interest:
As a sole propreitor, you risk being personally liable for the debts and liabilities of your business. If a creditor gets a judgment against your business for any reason, the judgment is also against you personally and the creditor may seek to collect the judgment by placing a lien on your house or garnishing bank accounts (even jointly owned accounts or property).
Likewise, your personal creditors (including spouses in a divorce) may be able to access the bank accounts, real estate and other assets owned by your business. If you forget to pay your car insurance this month and injure someone in a vehicle accident, that person will be able to recover what is owed to them through your business.
If your business may need to take out substantial loans, and you don’t want those loans to be reflected on your personal credit, your business will need to be incorporated. Otherwise, your ability to get funding personally or for your business may be hindered. Generally, financial experts say that it may take up to two years to start building business credit. Fortunately, I have found that there are a few lending agencies that are willing to work with business owners even before they reach their two-year anniversary.
Many investors are hesitant to invest in a business that is operating as a d/b/a (aka sole proprietor) because, ultimately, when the investors write their checks it’s made payable to “John Doe d/b/a Doe’s Construction” – which is ultimately John Doe, personally. They feel much better about making the check payable to an business entity (e.g., Doe Construction LLC) because there are rules and regulations that govern what the business can and cannot do with business funds.
One of the downfalls of forming a business entity is that you may be liable for additional taxes that sole proprietors are not liable for. Another downfall is that you may be subject to additional regulations requiring more paperwork on your part. So, when deciding whether to form an entity or not, you should weigh the risks against the benefits to make the best decision for you and your business.
About the Author
Amanda Jelks is licensed to practice law in Tennessee and Georgia. Her firm, Jelks Law, focuses primarily on legal matters that affect businesses and estates (wills, trusts, powers of attorney). Schedule a meeting with her today to discuss whether or not forming a business entity is in your best interest.
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