Disadvantages to Incorporating

Are There Disadvantages to Incorporating?

Choosing a Business Structure

Owning and operating a business can be a complex endeavor. Aside from basic business building and maintenance activities such as product or service creation, sales, marketing and staff management, you as a potential business owner have to decide which type of legal structure is best for your type of business.

You probably know that it’s common for business owners to form a separate corporate entity when starting a new business, but is that always the best route to go? Should I incorporate?

Let’s explore the subject of choosing a business structure more thoroughly.

What Are My Options?

As you work on forming your business you will find that you have many different options as far as choosing a business structure or entity is concerned.

Here is a list of the four basic types of business structures and some key information regarding how each type of structure operates:.

Sole Proprietorship

When you choose to list your business as a Sole Proprietorship, you are declaring that you will be the sole owner and operator of that business.

Sole proprietors have complete legal responsibility for all debts and other legal action pertaining to the business.

If something goes wrong or a business debt is owed, you as the sole proprietor will be wholly responsible for resolving the issue.

All profits from a sole proprietorship are funneled through your personal tax return, and any financial responsibilities or due taxes rest on your shoulders alone.

A common example of when a sole proprietorship would be a viable business structure is in the case of a freelance writer who works alone on writing projects for business clients.

This is the simplest and most cost effective way to structure a business, however it’s not a sufficient structure for every type of business, and it carries with it significant liability.

Partnership

Establishing a business with a Partnership structure is most common when two or more people join together to provide a service or product.

Each partner shares in the financial responsibility, but also the profits.  A partnership is similar to a sole proprietorship with the exception being that there is more than one proprietor.

A common example of when a partnership structure would be a viable choice is if two friends wanted to open a small electrical repair company in which the two of them alone would handle the workload.

Liability belongs to all partners listed on the partnership agreement. It is a joint venture, both financially and legally.  As with a sole proprietorship, this structure also carries with it significant liability.

Limited Liability Company

A limited liability company structure works similarly to a sole proprietorship or partnership with the exception that the business owner or owners are not legally responsible for the financial obligations associated with the business (with some exceptions).

For example, an LLC owner who is facing a lawsuit or an unmanageable amount of business debt will not be responsible for the financial implications unless they have personally guaranteed the debt or unless they are proven to have ignored the corporate formalities necessary to treat the LLC as a separate business entity from the owner.

The LLC structure provides some legal protection for business owners in terms of a business failure affecting their personal assets.  Because of the ease in which an LLC is formed, the simplicity of its maintenance, and the significant limitation of liability for its owners, it has become the most common business structure for small business in Arizona.

The Corporation is a business structure often chosen by larger businesses. The legal definition of a corporation is that it is a group of people authorized to act as a single entity and recognized as such in law.  Larger business utilize this business structure more often because of the great flexibility afforded by the division of ownership into stock, with owners of that stock being referred to as “shareholders”.

There are different types of corporations, however the general overview of an incorporated business means that:

  • The officers’ personal assets are protected from a business failure;
  • Management of the business is divided between officers, typically appointed by a vote of the shareholders;
  • Shareholders’ power is often determined by the “class” of stock the shareholder owns;
  • Corporations can continue indefinitely by changing board members, directors, etc.

Incorporation: The Pros and Cons

There are some great benefits to incorporating your business besides the benefits listed above. Incorporating your business means that you have legal right to sell shares of stock in your company.

You can also run your business somewhat anonymously if you aren’t eager to be public about your involvement with the business.

However, there are some disadvantages of incorporation as well. Here are a few things you may want to consider before you make the decision to incorporate your business.

Incorporating Can Be Costly

It costs more money to establish and maintain a corporation than it does a sole proprietorship, LLC, or other business structure.

Depending on the amount of capital you have available for your business, incorporating could be financially overwhelming.

Establishing a Corporation Involves Much Time and Paperwork

There are many legal documents that need to be filed if you choose to incorporate your business. Those legal documents include but are not limited to:

  • Articles of Incorporation
  • Company Bylaws
  • Certificates of good standing
  • Non-disclosure agreements

And more. Many business owners find the amount of paperwork and research needed to incorporate quite labor intensive.

Corporations are Subject to Stringent Compliance Regulations

Since corporations are monitored by the government and subject to the strict laws imposed on corporations, they must be willing to prove that they meet all required regulations and complete all required legal documents in order to remain in compliance. 

The legal documents required for sole proprietorships, partnerships and even LLCs aren’t nearly as numerous or time consuming as they are for establishing and maintaining a corporation.  

Incorporating Your Business Can Mean Double Taxation for You

One of the most prominent disadvantages of incorporation is that company profits are often double taxed.

Corporations are taxed first on their net taxable income, and then business owners are also taxed on any salary or dividends they receive via the corporation.

Therefore, a larger business income and profit is often required to make up for the double taxation on the business profits.

A Business Failure Can Have a Greater Loss Impact

When you are running a sole proprietorship and the business fails, the primary impact will fall on you and you alone.

However, when you are running a corporation the ripple effect of a business failure is much more significant.

Not only do you (and your fellow shareholders) run the risk of losing money via loss or elimination of stock values, you likely have employees that will lose their jobs and a major source of income for themselves and their families.

Also, if there is significant debt attributed to your corporation you may face costly legal battles as you work to dissolve the corporation amicably and in a manner where your creditors get paid.

The Bottom Line: Should I Incorporate My Business?

As you can see, there are many factors to consider before you take the steps to incorporate your business.

Fowler St. Clair works closely with businesses of all sizes in their corporate and business law matters. Our team of expert experienced attorneys focus on a limited suite of practice areas that include Real Estate and Business Law and Litigation, Estate Planning, Family Law and Criminal Law.

By keeping our focus limited to what we do best, we can provide you with the information and support you need to help make your business the best that it can be.

We can meet with you to assist you in deciding which type of business structure is best for your business, and we can work with you to create the required documentation needed to help ensure you have all of the necessary procedures covered from a legal standpoint.

Having the correct legal documents in place for your business is a vital step for any successful business venture.

Contact our team of experienced business law attorneys today to find out if incorporation is the best choice for your business.