When Should I Incorporate?

"When should I incorporate my business?" is a question on nearly every business owner will ask. If you own and run your business as an individual (i.e., a sole proprietor) and start experiencing success, you'll start to consider if now is the right time to incorporate. If you are in the planning stages, you may wonder when it's the ideal time for a business to incorporate.

It’s almost always beneficial to form your company earlier rather than later. This is true regardless of the type of business and whether you opt to form a C corporation, S corporation, or LLC.

CT Tip: Technically, an LLC is “formed,” it is not “incorporated.” However, people often use the word “incorporate” for both LLCs and corporations.

Businesses that incorporate earlier enjoy the benefits of incorporation to a greater extent than they would if they had waited. These benefits include:

  • Displaying a professional image to customers, suppliers, and investors
  • Greater ease in obtaining financing and funding
  • Possible tax advantages
  • Limited liability protection

Incorporating helps give your business a more established image with customers, suppliers, colleagues, lenders and others. The corporate form enhances your credibility and status, especially for an online business. As you are trying to establish and build relationships, having the “Inc.”  status gives you an edge when competing for business. Another consideration is to own domain names in the name of the corporation.

If you will not be able to fund the business yourself, bear in mind that incorporating often helps in raising capital and obtaining financing. Lenders generally prefer an incorporated business and may hesitate to provide a loan to a sole proprietor. Also, in contrast to a sole proprietorship, the incorporated business itself is an interest (e.g., corporate shares), which could help make a loan more appealing to lenders. Often, angel investors and venture capitalists prefer the corporate form over an LLC. The traditional status of corporations and the ease in transferring shares or adding new owners make the corporate form very attractive to many investors.

Incorporating your business may help lower your tax bill, although you should check with your tax advisor. For example, if you plan to reinvest most or all of your business income in the company, forming a C corporation may be a good choice because a C corporation can accumulate income tax-free. Also, S corporation owner-employees can divide the money received from the corporation between salary and dividendss do not pay the self-employment taxes that sole proprietors have to pay.

Incorporating Before You Sign Contracts Offers Limited Liability Protection

A well-established reason for incorporating a business is that operating as a corporation or LLC helps protect your individual and family wealth from business liabilities. This is true for online businesses as well as brick-and-mortar businesses.​ Running a business as a sole proprietor means that you and your business are one and the same. If an accident happens and the business is sued or if there is a contract disagreement, creditors could pursue your individual assets – including those that have absolutely nothing to do with the business.

When you incorporate, the corporation or LLC becomes a legal “person.” It can sign contracts, borrow and lend money, invest, and own property. Signing your business contracts on behalf of the corporation helps protect your personal assets.Creditors can pursue the business assets but generally cannot reach your non-corporate, personal assets.

CT Tip: If you sign a contract as a sole proprietor and later incorporate, you are still individually liable on that contract. For that reason, it's generally better for incorporate or form your LLC before signing agreements, contracts, leases, etc. If you are considering a franchise, it’s generally better to incorporate before you sign any agreements. Also, even after you have incorporated, you can be personally liable if you sign as an individual rather than on behalf of the corporation.

Incorporating Helps Establish Business Interests Among Founders

If a business has more than one founder, a clear understanding of ownership interests helps the business grow harmoniously and effectively. Various owners may own different amounts and types of shares that reflect their interest in the business Incorporating early helps to “nip in the bud” any problems that could arise later from unintended misunderstandings and keeps everyone on the same page regarding who owns what and who is owed what.

CT Tip: When you incorporate, you own a corporation as a shareholder and an LLC as a member. Your ownership percentage and rights are reflected in the shares of the corporation or membership interested in an LLC.

If your business will have intellectual property (e.g., copyrights, trademark, patents) or other property, incorporating could be an important step in ensuring the business owns the property rather than any individual founder.

Incorporating Before Hiring Employees Helps to Protect Your Assets

Businesses that have or expect to have employees should incorporate before hiring them. Employers are generally liable for their employee’s actions and mistakes. If you run your business as a sole proprietorship, then you as an individual are liable for your employee’s actions, negligence, mistakes, etc. This exposes your assets (including non-business assets) to liability. However, if you incorporate and the corporation is the employer, the business takes on this liability risk. For this reason, it’s best to incorporate before you hire any employees, in order to help protect your individual wealth and family assets.​

Incorporating Helps You Bring Other Owners Into the Business

If a sole proprietor wants to bring in a business partner as a co-owner, incorporating helps make this possible. Corporations are owned by shareholders who hold shares in the corporation. When there is more than one owner of an incorporated business, each owner owns a certain percentage of shares. Also, each owner could have different types of stock (e.g., common, preferred, etc.).

CT Tip: Under IRS rules, S corporations may have only one class of stock, (although that class can include both voting and non-voting stock). If you would like to form an S corporation, be sure you create no more than one class of stock when you incorporate.

Are There Downsides to Incorporating Too Early?

Because incorporating involves paying state filing fees, those fees are a potential downside to incorporating too early. Corporations, LLCs, and other business entities typically must file annual reports and pay the accompanying fees every year (or every other year, depending on the state). Also, operating as a corporation involves corporate formalities, such as annual shareholder meetings. And, once you have incorporated, you must dissolve the corporation or LLC to avoid annual report requirements. If you are only thinking of starting a business and have not taken any other action, you may wish to wait until your plans become more concrete.

Once you know you’re starting a business, however, it’s generally far more favorable to incorporate early in the process. This allows you to sign contracts and other documents in the corporation’s name and take far greater advantage of the limited liability and other benefits incorporating has to offer.

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