Pros and Cons of Turning Your Small Business into a Corporation
As a small business, you have various options when it comes to the legal structure. Many small businesses classify as sole proprietorships or partnerships, but incorporation is an option as well. From greater financial resources to lessened legal liability, there are plenty of reasons to incorporate, but there are some drawbacks as well. FindLaw identified some pros and cons of incorporating a small business. Find the advantages and disadvantages of becoming a small business corporation below.
Owner Protection from Legal Liability
Once a new business’s owner(s) successfully completes the incorporation process, the owner(s) have a limited amount of legal liability for the corporation’s business activities and debts, because in the eyes of the law the corporation is a separate entity. In order to maintain this limited liability, the corporation’s owners must follow a number of legally required corporate formalities.
Ability to Attract Investors
The corporation’s ability to issue stock is a strong selling point to those willing to invest capital in a business venture.
The corporate business form has an established power and management structure: directors, officers, and shareholders. Each group has its own set of clearly-defined roles and responsibilities within the corporate framework. See “Corporate Structure: Directors to Shareholders” for more details.
Stock and Stock Options for Employees
Especially for larger businesses, the corporate business structure offers an appealing opportunity to potential employees — stock benefits and stock options (the employee’s right to buy stock at a locked-in price).
Time and Cost of Incorporation
The incorporation process can be expensive and time-consuming. A number of documents must be prepared (including the new corporation’s articles of incorporation and bylaws), and filing fees must be paid to your state’s Secretary of State office (or similar business filing agency).
Following Corporate Formalities
All corporations must observe a number of corporate formalities. These steps include holding regular meetings of directors, keeping records of corporate activity, and maintaining the corporation’s ongoing financial independence. See “The Basics of Small Business Incorporation” to learn more.
Potential Tax Liability
There is the risk of “double tax.” The corporation pays taxes for any profits earned. Then, any individual stockholder who earned profits from the corporation (in the form of paid “dividends”) also pay tax. This occurs most often in larger corporations. Therefore, it may not be an issue for stockholders and owners of smaller corporations, who often work for the business itself and are paid salaries rather than dividends. One solution to the double-taxation problem is electing “S” corporation tax status.
Should You Incorporate?
A corporate structure would completely change how you do business. It’s a long process to implement, however, and comes with plenty of new legal requirements. But it can mean more security for the business in the long run, access to more investors, and limited liability. The choice is not right for everyone, but, for some, it can be extremely beneficial.