Why You Need to Form a Business Entity

Some companies can cover many of their potential business risks with insurance, but in my opinion, if you're going into business you should form a separate entity. The risks to your personal assets and to your business growth far outweigh any advantages of sole proprietorship. Still not sold? Check out the risks you're facing.

1. You're facing the world naked.
Doing business as a sole proprietor is like going into battle without armor. Even if you have insurance, it won't protect you against certain things, like lawsuits that exceed the policy amounts. As a sole proprietor, you place all of your personal assets at risk. One freak lawsuit, and you could lose it all: your home, your bank accounts, your savings, your car and your jewelry. I can't tell you what the odds are of being sued, but I'd sleep better at night knowing I had a layer of protection.

2. Bankruptcy records last a long, long time.
If your industry changes, clients dry up or you're slapped with a judgment you can't pay, you may be facing bankruptcy. Corporations and LLCs have the option to go through a bankruptcy proceeding that doesn't include the business owners. Sole proprietorships don't have that option. Although technically it's a fresh start from old debt, bankruptcy impairs your ability to get credit cards and other needed financing. Plus, a bankruptcy can stay on your credit record for 10 years or longer.

3. Larger companies may not want to work with you.
Are you looking for consulting work with larger companies? If so, operating as a sole proprietor may disqualify you from plum projects. Why? Larger companies like to use independent contractors because they can avoid paying Social Security and Medicare taxes. If a consulting assignment lasts a long period of time--some can go for months or years--you start to look suspiciously like an employee. As a result, more and more companies will only do business with consultants who operate their businesses as corporations or LLCs. Does it make sense to be passed over for a $50,000 assignment because you wouldn't spend $500 getting incorporated?

4. You limit your opportunity to expand.
Tired of doing it all yourself? If you're thinking of bringing on a business partner, you're out of luck. You can't have a partner in a sole proprietorship; you have to form a different business entity. If you'd formed a corporation or LLC from the start, you'd have more options and better control over who joins you and on what terms. Give some thought to the future of your business. Your form should reflect not only what's convenient for today, but also what will help you grow tomorrow.

5. You risk falling into "scarcity thinking."
Every time you say, "No, I won't spend the money on that," what kind of choice are you making? Do your reasons truly support the health and growth of your business, or do they reflect your fears and insecurities? While it makes good business sense to keep your spending within budget, you need to invest wisely in your business.

Forming a corporation or LLC will probably be one of the first important investments you make in your company. If you're still hesitant, ask yourself why. Are you afraid of building a company that outgrows you because you crave control? Are you worried about starting your business with an entity whose minutiae you don't fully understand because you don't want to need help? Are you concerned about the ongoing taxes and costs of the entity? All of these may be a reflection of scarcity thinking.

Forming a separate business entity is a crucial first step in the life and growth of most companies. Don't waste your time worrying about worst-case scenarios. Find a small business attorney and accountant to help you make the decision, then spend your time focused on all the good things that'll happen for you.