Getting a new business off the ground is challenging enough, but it can feel downright overwhelming when you consider the legal ramifications. While not every startup needs to take the step of incorporating or forming an LLC, it’s a good idea if your business will expose you to risk or you want to approach certain funding options. Here are five situations in which it’s a good idea to consider a formal business structure.
1. You are forming a startup with other people
No matter how close you are, there’s always a risk when you start a business with a friend or family member. What happens if, at some point in the future, you disagree about how the business equity should be split? Forming an LLC or incorporating allows you to formally define ownership in the business to avoid conflicts later.
2. You plan to approach venture capitalists
If you want to approach venture capitalists or angel funders, keep in mind most will only work with you once you have a formal structure in place to accept investments. If you’re set on raising venture capital, the C-corporation is usually the best choice for a startup.
The S-Corp is a popular choice for many small business owners and entrepreneurs but it has regulatory restrictions that make it difficult to raise venture capital. An LLC, meanwhile, makes it hard to raise venture capital because it’s a pass-through tax entity, which is undesirable to most venture capitalists. In fact, many venture capital firms have provisions that restrict them from investing in any legal structure other than a C Corporation.
Related Article: S Corporation Pitfalls to Avoid
3. You want liability protection to offer a service or product
One of the greatest benefits of incorporating your business or forming an LLC is gaining personal liability protection. This means if your business is sued by a customer, vendor, or creditor, you won’t be personally liable and you won’t risk losing your car, house, or savings.
What happens if someone gets hurt with one of your products? What if you or an employee damage a customer’s property or someone gets hurt? Without the protection of an LLC or corporation, you can be personally responsible for any damages.
4. You want to raise money through crowdfunding
It’s not uncommon for startups to seek funding on crowdfunding sites like Kickstarter and Indiegogo. While it’s easy to start a crowdfunding project, keep in mind that you’re really just seeking hundreds of investors. What if your business doesn’t take off like you hoped? What if you have trouble making the product you promised? It may be a good idea to incorporate or form an LLC before you seek funding to avoid personal liability.
5. You want to establish business credit
If you hope to establish credit for your fledgling business, be aware that you can’t do it as a sole proprietor. If you own a partnership or sole proprietorship, you will need to sign all business contracts in your own name with your own personal guarantee. There will be no legal separation between you and your business, which means any “business” credit you need will appear on your personal credit report.
While it can take time to build credit for your business even with an LLC or corporation, it’s an important step if you hope to one day apply for loans on your company’s name and credit rating without risking your personal assets.
Author: USA Corporate Services, Inc. is a company dedicated to helping entrepreneurs protect themselves by establishing a formal business structure for their startup. USA Corporate offers company formation services as well as registered agent services, mail forwarding, and business startup resources.