We often take it for granted that entrepreneurs will incorporate a business. After all, helping small business owners incorporate or form an LLC is one of our primary services! We work hard to educate entrepreneurs about how the incorporation process works, covering everything from incorporation benefits to the differences between various legal entities.
However, what we rarely discuss are the dangers of an unincorporated business. What happens if an entrepreneur decides they don’t want to incorporate their business? An unincorporated business may be subject to more issues than the entrepreneur realizes — and these can leave behind a long-term impact that an incorporated startup would not have to face otherwise.
An unincorporated business won’t receive liability protection
When entrepreneurs decide to form a business entity, like a limited liability company (LLC) or corporation, they receive extra liability protection for incorporating under that legal structure.
Liability protection ensures that professional and personal assets remain separate. The small business becomes a separate entity from the business owner. In the event of an unforeseen circumstance, such as a lawsuit, only the business will be held responsible for its actions. The houses, cars or other valuable items an entrepreneur possesses will not be seized or sacrificed as payment. This is because liability protection ensures the safety, and separation, of all personal assets.
Liability protection is a major asset across many industries, especially those in working conditions where employee safety may be compromised. Two examples include the construction and hospitality industries, where it is possible for employees to experience injuries on-site. If an entrepreneur does not incorporate their business, they do not receive liability protection. In the event of an injury or property damage, the owner of an unincorporated business is responsible for everything from incurred debt to lawsuits.
It’s harder to establish credibility with an unincorporated business
There are certain industries where having a strong brand reputation is the key to differentiating your brand from the pack.
- Retail: Customers should be able to trust that their purchases are high quality and will not break or fall apart days after purchase
- Medical practices: Patients should feel that physicians and healthcare workers have their best interests in mind and possess the qualifications necessary to resolve their health issues
- Hospitality: Hotels, restaurants and event spaces may aspire to reach 5-star status. Increasing their credibility with customers, vendors and suppliers will help them to achieve this goal
- Consultants: Individuals that pursue consultancy understand that proven expertise is everything. They must be able to display a track record of success within their field in order to retain existing clients and obtain new ones
If an entrepreneur does not incorporate a business, it becomes all the more difficult to establish credibility with consumers. Customers may feel less comfortable about doing business with an unincorporated business because of all the “what if?” questions: What if there’s a data breach during a transaction and my credit card information falls into the wrong hands? What if a surgery goes awry? What if I slip and fall in the hotel lobby?
If a business is incorporated, it’s allowed to include an “Inc.” or “LLC” mention after the business name (depending on the type of incorporation). This is readily visible to all current and potential consumers, who can see that it has taken the proper steps to become a legitimate, professional establishment. Customers feel better about doing business with a reputable company. (That good experience translates into increased word-of-mouth to other potential clientele, too!)
Unincorporated businesses miss out on tax savings and struggle to build credit
Did you know that when you incorporate a business, it is possible to save up to 50 percent on taxes? This extra cash may be allocated to help grow the business in other areas, making it a win-win for the business and its entrepreneur.
Unincorporated businesses also struggle to build business credit more than their incorporated counterparts. Let’s say, for instance, you incorporated as a sole proprietor. This is one of the few entities that does not provide liability protection, but it allows you to exercise full control of the business. However, that means you are responsible for all aspects of the company. In the event that you wanted to build or increase a line of business credit, potential lenders and investors would examine your personal credit history. This could become an issue for an entrepreneur who has poor personal credit, or has fallen into debt. The credit history of the business would not be reviewed because, under a sole proprietorship, it simply would not have one. The struggle to build business credit is alleviated considerably when a small business owner chooses to incorporate, thus separating the personal from the professional.
Should you incorporate your business?
Incorporating a business is ultimately the entrepreneur’s choice. Many opt not to incorporate because of the paperwork and fees involved in the process. Others, in an effort to get their business up and running as quickly as possible, may even forget to incorporate entirely.
However, it’s in the best interests of entrepreneurs to incorporate a business. Doing so creates a foundation that protects and helps build your growing company.
If you feel lost on the type of entity to incorporate as, try MyCorporation’s Entity Choice Wizard. Through a series of multiple choice questions, this tool allows you to figure out which entity is the best type for your small business. After taking the quiz, you’ll be ready to incorporate as a legal structure that is truly the best fit for your business.
Editor’s note: This post first appeared in slightly different form on the MyCorporation.com blog.