Setting up the right legal structure for your business may seem like a boring detail that you do not need to spend much time on. In reality, selecting the right entity for your company is one of the most critical decisions you can make as a business owner.
That said, there are all sorts of myths surrounding business entities and this can cause confusion and lead to costly mistakes. In today’s article, we will discuss four (4) of the most popular myths about business entities and how you can avoid falling for them.
Myth 1 | Small businesses do not need a business entity.
Although it is possible to run a business without creating a formal a business entity, doing so puts you, and everything you own, at risk. Without the proper entity set up, there is no separation between your business and personal assets. Consequently, your personal assets could be at risk in the event your business goes into serious debt or gets hit with a lawsuit.
For example, if your company is structured as a sole proprietorship or general partnership and you go out of business, your business creditors would come after your personal assets to pay off your business debts. The same is true if your business is ever sued.
In contrast, by structuring your business as a limited liability company (LLC), or a corporation, you can shield your personal assets from liabilities incurred by your business. When properly set up and maintained, such business entity structures establish your company as a separate legal entity distinct from you as an individual. This strategy could prevent you from being held personally liable for the company’s debts or legal disputes.
Myth 2 | There is no need to set up an entity for your business until it is profitable.
It may seem like a good idea to delay setting up your business entity until you are actually earning revenue, or even making a profit. In reality, you should have your entity in place from the very start, even before starting your operation or providing services. This is true, not only because liability can arise well before you are profitable, but also because incorporating your business is likely to lead to even more income and profit.
For example, having the proper entity in place in the early stages allows you to receive credit in your business’ name, and raise money from investors. Not to mention, the act of incorporating itself shows that you take your company seriously, which can inspire increased interest from customers, vendors, and financial backers.
Myth 3 | A corporate entity offers absolute liability protection.
When properly created and maintained, entities like an LLC or corporation can shield your personal assets from creditors, lawsuits, and other liabilities incurred by your business. However, the protection afforded by these entities is not absolute.
There are a number of circumstances in which a creditor can come after your personal assets to settle a claim against your business. When this happens, it is known as “piercing the corporate veil.” While the corporate veil can be pierced if you commit fraud or negligence, in most cases, it happens due to innocent mistakes. These errors can include inadvertently mixing your personal and business finances, personally signing off on a business loan, or failing to abide by administrative formalities.
Finally, while a corporate entity can protect your personal assets from liability, these legal structures do not offer any protection for your business assets. To safeguard your business assets, you will need to invest in the proper business insurance, which is always your first line of defense.
Myth 4 | Incorporating in Delaware, Nevada or Wyoming is always best.
You may have been told—perhaps even by another lawyer—that establishing your corporate entity in Delaware, Nevada, or Wyoming is your best bet for tax purposes. For most businesses; however, incorporating in these states is completely unnecessary—and it may even cost your company in the long run.
Although many companies do incorporate in these states, it is for very specific reasons, such as to raise investment capital or take advantage of favorable securities laws to go public. Unless you are actually doing business in these two states, your company is not going to receive any significant tax benefits or additional asset protection by incorporating there.
While Nevada and Delaware do not have state personal- or corporate-income taxes, that does not mean your business will avoid state-level taxes entirely. The fact is, if you are a resident of, or doing business in, a state that has state income taxes, you still must pay those taxes, even if you are incorporated elsewhere.
Moreover, if you incorporate outside of the state where you live or conduct business, you must file as a foreign registrant in your home state. Such double filings can result in extra filing fees and administrative expenses that make out-of-state incorporation financially unfeasible.
There are instances where it might make sense to set up your business entity in states like Delaware or Nevada, or even Wyoming or South Dakota.
We Can Help!
Setting up the right entity for your business is not something you should take lightly or try to do all on your own—there is far too much at stake.
We offer our clients trusted advice on the legal entity that is most advantageous for their specific business, while also ensuring that the business entity is properly set up with all the necessary agreements and other resources in place.
We would welcome the opportunity to assist you with your business ventures. We will help you decide the best location for establishing your business entity and provide your support in navigating the requirements for maintaining a business entity in each state you do business. Additionally, we will provide you with a variety of business systems, which will not only make your operation more efficient, but also establish a clear separation between your business and personal finances, which is a vital part of maintaining your entity’s liability protection and safeguarding your personal assets.