Tuesday, October 18, 2011

Ask a Lawyer - "Why Should I Hire a Lawyer to Help Incorporate My Business?"

Having just finished a three-part answer to the last question in the "Ask a Lawyer" series, about why to consider hiring a lawyer to help with your will and estate plan, the next question in line also requires a multi-part answer.  The question is "why should I hire a lawyer to help incorporate my business?"  To help provide a thorough answer, we will break the question down as follows:
  1. How do I know what type of entity is appropriate for me and my business?  Should every business incorporate?
  2. What's the difference between a corporation and a limited liability company?  Which should I choose?
  3. Why should I hire a lawyer to help form my corporation/limited liability company?  Why not do it myself?
I will address question 1. above in this post.  To decide which type of entity is best for you, it's important to understand what are your options.  I will list the most common choices here with a very brief description of each.
  1. Sole Proprietorship - essentially, you are the only business owner, and you personally stand behind everything you do.  The business entity is you.  Illinois law does not require sole proprietorships to register with the State (although if you operate with a business name other than your personal name, you are required to register that "assumed name" with your county government).  
  2. General Partnership - Similar to 1, except there are two or more business owners, each personally liable for the business.  
  3. Limited Partnership - Again two or more business owners, but in this case one partner is required to be the "General Partner" personally liable for the business, while the other partners may be "Limited Partners" who are not personally liable for the business.  An LP is required to be registered with the State.  A written partnership agreement is required.
  4. Corporation - A corporation is owned by Shareholders, managed by a Board of Directors, and its day-to-day operations are carried out by its Officers.  A corporation is formed by registering with the State.  The corporation then can either be classified as a "C" corporation or an "S" corporation for tax purposes, depending on how the corporation files with the IRS.  When properly formed and managed, the Shareholders of a corporation are not personally liable for the business.
  5. Limited Liability Company - a limited liability company ("LLC") is another option for owners who wish to form a business entity for which they will not be personally liable.  The owners of an LLC are its "Members."  The LLC can elect to be managed by its Members or to appoint a separate "Manager" for the business.  An LLC is formed by registering with the State.  
I will be elaborating further on corporations and LLCs in upcoming posts.  For now I want to address the second part of the first question in this series, "Should every business incorporate?"  

The answer has to be "not necessarily."  Certainly every business owner could potentially benefit from having limited liability, but at what cost and what is the business owner's risk exposure?  For example, should my kids incorporate their lemonade stand business?  Probably not.  Are they (and me as a parent) exposed to potential liability risk?  Sure.  Maybe they serve someone who has an allergic reaction to the lemonade.  Maybe some lemonade gets spilled on the sidewalk and someone slips and falls.  The business owners (and in this case their parents!) need to weigh the liability risk against the cost of limiting their liability by forming a corporation or LLC.  

There is nothing wrong with choosing to being a Sole Proprietor, if you have weighed the risk and cost involved and have made a conscious business decision not to incorporate at this time.  Lawyers (myself included) tend to be risk-adverse to this decision, and for good reason.  We see clients all the time whose business catastrophe has quickly become a personal catastrophe, due to exposing oneself to business liability risk, often thoughtlessly.  I would caution you to make sure you truly do consider all the risk and costs involved carefully, and not simply decide to operate as a Sole Proprietor because it is "cheaper."  Consider, for example, whether incorporating would give credibility to your business, thus increasing revenue and perhaps be looked at favorably by your lender.  Also consider what kind of business insurance are you carrying and is it appropriate for the risks involved?

Finally, if after weighing the risks and costs/benefits involved you decide to remain a Sole Proprietor for the time being, consider what it would take to change your mind, and consider writing into your Business Plan a commitment to form a limited liability entity appropriate for your business within a defined, fairly short, period of time, or upon reaching an attainable revenue goal.  Put it in your budget, and allow sufficient funds to obtain some legal advice to make sure you do it the right way and truly mitigate your risk exposure (more on that later!).     

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