In this article, I am going to talk to you about whether your business should be in an entity like a corporation or a limited liability company, usually called an LLC. For purposes of this discussion, I’m assuming that you don’t have any partners or investors, that you are what’s commonly known as a sole proprietor. If you have a partner, then I strongly recommend some kind of entity other than just a general partnership, which I discuss in another article.
Whether or not you need an entity at all depends on a number of things.
Those things include:
1. The kind of product or service you’re selling?
2. Whether your business is open to the public?
3. Whether you expect to make or lose money when you start your business?
4. Whether you’ll have employees?
5. What’s your general risk tolerance
Let’s talk a little bit about what an entity like a corporation or an LLC does for you. Corporations and LLCs were created for the purpose of protecting their owners, directors, officers, members and managers from personal liability for claims against the entity. Those claims include claims in contract or in tort. That kind of liability is known as vicarious liability.
So, although a shareholder is not vicariously liable for the obligations of the entity, each shareholder (or officer or director or manager or member) is responsible for his or her own acts. If you are an owner, and you personally do something negligent or wrong, or you sign a personal guarantee, guaranteeing, for example, the lease for the office space for your business, then you will be personally liable, and entity protection won’t help you. Enron is a good example of the amount of liability that can personally attach to executives of a business when those executives do bad things.
So, in answer to question #1, if the service you’re providing is a personal service, like the supply of data or technical information, or professional services (like me), then having your business in an entity may or may not be useful to you. Because if you provide bad information, then not only will your customer have a claim against your entity, but will also have a claim against you personally. This is why I deal closely with business insurance brokers, and it may very well be that all you need is insurance. And though I don’t make any money when you do that, if that’s the best decision for you, then that’s what I’d advise.
That said, even if your services are personal, but you invite the public into your office (like I do) or invite them to interact on your website, or you have employees, those might be good reasons to have an entity. Employees can do things over which you have no control; the claim for the negligence of your employee will typically not attach to you personally if you have an entity. And a customer who slips and falls in your office will typically be limited to suing the entity and not you personally.
As for your cash flow, you may wish to set up an entity that takes advantage of the current tax law, and a full discussion of that issue is beyond the scope of this article, but just to keep in mind that an entity may, in fact, help you to save thousands of dollars on taxes.
So, do you need an entity for your business? Some of it is about your own personal risk tolerance, and having some kind of limited liability entity is almost always a good idea. But there are some things to consider, like what you are providing, if you have employees, are you open to the public, and your cash flow.
You need to take a moment and consider those aspects before incurring that additional overhead expense.
My disclaimer is here, and you’ve read it.