#051
The Entrepreneur's Guide to Incorporating Your Business
Read time: 6 min
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Ever find yourself wondering when is the right time to incorporate your business?
And more importantly, how you should incorporate?
You’re not alone.
Many entrepreneurs grapple to understand what a sole proprietor or partnership is; even more challenging is knowing when to make the decision to shift to a more formal business structure.
It’s a big step and it comes with a host of questions about legal protection, tax benefits, and timing.
In short, incorporating your business is about legally protecting yourself, building credibility, and structuring your business to match your goals.
But how do you know when it’s the right move for you? And what do all those different business structures (LLC, C-Corp, S-Corp) really mean for you as a business owner?
Today, we’re diving into incorporating your business. We’ll explore why you might want to incorporate, break down the different types of corporate structures, and how they’re taxed so you can make an informed decision.
By the end of this article, you’ll have a clearer picture of the path that’s right for your business and will be armed with the knowledge to ask the right questions.
So, let’s get started!
But first a quick note: I am not a licensed legal or tax expert. This information is meant to educate only. Before making any decisions, I strongly encourage you to speak with a lawyer and CPA.
Understanding Unincorporated Business Structures
There is zero requirement for you to incorporate your business.
Nothing is stopping you from selling custom t-shirts from your garage over the internet without any corporate structuring, business license, by-laws, etc.
This is simply called a Sole Proprietorship. A one-man (or woman) show with your name as the business at its most basic level.
You can have a business bank account in your name, accept credit cards in your name, and advertise as your name.
If you want to get a fancy and call your business something else, you can apply for a fictitious business name, sometimes referred to as a DBA or “Doing Business As”.
This allows you to open a business bank account in a name other than your own, which is useful when you’re collecting payments allowing the invoices, checks, and credit cards to all show your official business name.
It’s an added level of professionalism that builds credibility as a company.
If you have one or more business partners – whether through a formal contract or a simple handshake (I strongly discourage against the latter) – you have a partnership. It’s the same as a Sole Proprietorship, but for a group.
At the end of the year, any profit you generated as a business is simply earned income you’ll report on your taxes. There is no distinction between you and your business.
However, because there is no separation between personal and business assets, this leaves you exposed to legal and financial issues.
If someone sues your business because they hypothetically had an allergic reaction to your t-shirt, they’re also suing YOU. Your house, your savings, your car… they’re all accessible should the lawsuit go south.
Which brings us into the next topic.
Why Incorporate Your Business?
There are four main reasons why you would want to incorporate:
- Credibility
- Tax benefits
- Legal protection
- Growth opportunities
Credibility
Incorporating can significantly enhance how your people perceive your business.
Clients, customers, and investors view incorporated businesses as more legitimate and trustworthy, which is needed if you’re ever going to grow beyond being a small, word-of-mouth operation.
The formal structure of an incorporated business creates legal and financial transparency that signals you’re a serious business, which opens doors to additional funding and growth opportunities through investors and financial institutions.
Tax Benefits
Incorporating your business also carries significant tax advantages.
Different business structures offer various ways to reduce taxable income through deductions. For example, corporations can deduct expenses such as salaries, health insurance premiums, and operational costs.
Additionally, depending on your business structure (like an S-Corp which we’ll get into shortly), you might avoid double taxation on profits, paying taxes only on your personal income.
Understanding these benefits can help you save money which you can reinvest into growing your business.
Legal Protection
One of the most compelling reasons to incorporate your business is the legal protection it provides.
When you incorporate, your business becomes a separate legal entity. This separation means your personal assets – like your home, car, and personal savings – are protected from business liabilities.
If your business faces a lawsuit or incurs debt, your personal finances remain secure, which is a critical safety net for any entrepreneur.
Growth Opportunities
As your business grows, you may need additional funding to expand operations, develop new products, or enter new markets.
Incorporated businesses find it easier to raise capital through the sale of stock or securing loans, as investors and banks are more willing to invest in entities with formal structures and legal protections.
Additionally, incorporation allows for the possibility of perpetual existence, meaning the business can continue even if ownership or management changes, which can be an attractive feature if you’re ever looking to sell your business.
Now let’s look at what options you have when incorporating.
Overview of Incorporated Business Structures
There are three main types of corporations you should be aware of:
- Limited Liability Company (LLC)
- C-Corp (Traditional Corporation)
- S-Corp
For purpose of this article, we’re only going to focus on LLC and C-Corp because an S-Corp is simply a tax election you make regarding how your business pays its taxes.
S-Corps are “pass through taxation” which means the business doesn’t pay any taxes. Only the owners do. LLCs can be formed with an S-Corp election, so I’ll make that the assumption as I compare LLCs and C-Corps.
We’ll analyze them in two ways:
Structure
An LLC is a flexible business structure that allows for an adjustable management setup where owners (also called members) can either manage the business themselves or appoint managers to do so.
They have fewer restrictions on ownership, permitting an unlimited number of members that can include individuals, corporations, and even other LLCs.
The formation of an LLC is also easier and less formal compared to a C-Corp, requiring only the filing of articles of organization with the state and creating an operating agreement.
In contrast, a C-Corp is a more formal business structure with a clear distinction between ownership and management. For context, large, publicly traded companies like Amazon and Netflix are C-Corps.
It requires a board of directors to oversee the company and officers to handle day-to-day operations. Ownership is represented by stock shares, which can be sold to raise capital to an unlimited number of shareholders, including institutional investors and foreign entities.
Forming a C-Corp involves filing articles of incorporation with the state(s) it’s operating in and creating bylaws.
Taxation
When it comes to taxation, an LLC typically enjoys pass-through taxation, meaning it is not considered a separate tax entity.
Instead, the profits and losses of the business are reported on the personal tax returns of the members, thereby avoiding double taxation—where both the business's income and the owner's income are taxed.
In contrast, a C-Corp is taxed as a separate entity.
This means that the corporation files its own tax returns and pays corporate income taxes on its profits.
This structure can lead to double taxation: first at the corporate level on the company's profits, and again at the individual level when dividends are distributed to shareholders.
However, retained earnings in a C-Corp can be reinvested into the business at a lower corporate tax rate, which can be advantageous for growth and expansion.
In general, I recommend starting as an LLC, then re-designating as a C-Corp if your circumstances change – often a very good thing. There’s no reason to complicate and over-think your business’ structure.
Incorporating your business is a significant step that can provide legal protection, tax benefits, increased credibility, and greater growth opportunities.
By understanding the differences between unincorporated structures like sole proprietorships, and incorporated structures like LLCs and C-Corps, you can make an informed decision that aligns with your business goals.
While LLCs offer flexibility in management and taxation, C-Corps provide a more formal structure with the potential for raising substantial capital. Each option has its own advantages and complexities, so it's crucial to evaluate your specific needs.
If you're looking for a step-by-step process on incorporating, you can get my Business Launch Guide. It breaks down starting your business into 3 phases: ideation, planning, and execution.
This week's Harder Not Smarter Podcast episode:
EP 019 of the Harder Not Smarter Podcast w/ General David Petraeus - hosts former Navy SEAL Kevin Seiff and former Green Beret Greg VanDyne dive into an insightful conversation with General David Petraeus. A retired four-star general renowned for his leadership in Iraq and Afghanistan and his tenure as the Director of the CIA, he shares his experiences and perspectives on life after the military. He discusses his influential role at KKR Global Institute, his contributions to academia, and the importance of strategic leadership. The discussion also covers pressing geopolitical issues, including the Israeli-Palestinian conflict, the US-Israeli alliance, the ongoing conflict in Ukraine, and issues with the cartel south of the US border.
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