When To Incorporate
When should you incorporate? There are three basic forms of business organization, and of them the corporation is the most successful. There are some reasons why this is so.
Why incorporate? The reasons for the corporation as the favored type of business organization are simple and compelling.
Death and taxes, these two things are considered the inescapable, and for businesses these two things are major keys to the success of the corporation. However there are other considerations that weigh heavily in favor of the corporation. Liability and continuity of operation are two of the main reasons businesses choose to incorporate. Of the three major forms, the sole proprietorship, partnership, and the corporation, it is the corporation that has proven the most viable and dynamic in the world of business. A comparison of the three forms in terms of liability and continuity makes it clear why businesses choose to incorporate.
The sole proprietorship is a business that has its owner as the sole and controlling influence and beneficiary of the business operation. The single owner makes all decisions and is operates the business as an extension of his life. Profits from this form of business organization are considered as income of the proprietor, and the business is part of the owner’s personal property. Therefore its (the business) assets are part of his estate upon his death, but the business itself dies with its owner. As far as taxes go, income from the business is regular personal income, and is taxed as such. This means that while there is an advantage of being totally in control, the disadvantage is that the business is an extension of the owner’s personal holdings.
The greatest disadvantage of the sole proprietorship form of business may be in the fact that it links a business to the personal holdings of an individual. This means if any debts, judgments, or other liabilities are incurred by the business, they are the individual responsibility of the business’ owner. For example, if a small store who has a sole proprietor as an owner has debts or judgments against it, the debt can be collected from the personal holding of the owner. If a customer successfully sues the business, even if the owner had nothing to do with the action, as a sole proprietor, all his personal and business assets may be attached to satisfy the debt. In short, there is an almost unlimited personal liability to the owner of the business.
The partnership has several advantages over the sole proprietorship, but there are two disadvantages. Partnerships can be designed so partners can shape responsibilities, and obligations in a formal understanding that reduce many of the risk faced it either were to own alone. Like the sole proprietorship, the partnership has the proceeds of the business being taxed as regular income. It is death which causes the greatest difficulty, however. In a partnership the death of either partner automatically dissolves the partnership. The heirs of the deceased partner have the right to force the immediate liquidation of all the assets of the business to extract what they believe is favor value for their inheritance.
The corporation has two major factors that set it apart. It has a defined lifetime, which in most cases is indefinite, meaning that corporations usually are immortal. The second is that the corporation affords its owners limited liability.
Shares of corporations (which represent pieces of ownership) can be passed on, or sold without affecting the day to day operation of the company. If the owner of the shares were to die, the shares may be transferred, sold, or held in an estate, and the corporation is allowed to continue to operate based on the rules set in the corporate bylaws of the company. Death of any individual doesn’t effect the functioning of a well designed corporation.
Liability is the other advantage of the corporation. If a corporation has debts, judgments, or liabilities against it, the owners of the corporation cannot have their personal assets affected. The debt owed can only be collected from the assets of the corporation. This means that if for some reason the corporation amasses debt and fails, those owed money by the company can only be collected from available corporate assets. The assets of the owners of the corporation, or shareholders, are untouchable.
There are other advantages to the corporate form, and some disadvantages, but it is the fact that corporations allow for continued operations and maximum flexibility, and a freedom from personal liability that make the corporate form of business structure the most desirable. So much so that even individuals and partners form corporations to protect personal assets by limiting liability. They organize as corporations to insure smooth transitions, and enjoy liability protection. As a matter of fact, the corporate form of organization allows the maximum flexibility, and the minimum in personal liability.
The corporate structure gives companies the advantage of acting as individuals who are immortal. Ownership in a business with liability that is limited to the assets of that business, a way to transfer ownership without affecting business operation, and a way to organize any business along a formal set of rules that allow for the operation of a business beyond even the life of any individual.
While this explanation of business forms is far from complete, it does point out the main reason for the number and strength of companies who incorporate.