Business Law - Why Incorporate?

Every now and then someone asks us why they should incorporate their business. After all, they say, why not just continue in business and use Schedule C of the IRS 1040 form to pay taxes on the business. Moreover, to incorporate invariably costs money - fees are paid to the Secretary of State (at least for an Illinois corporation) and annual fees are paid thereafter. There is also a modest legal fee as well.

Incorporation, however, is an absolute must for every business.

First, in most cases incorporation prevents a creditor from seeking to hold the owner of the business personally liable. If you are in business without a corporation, and something goes wrong, the creditor can seek to collect from your personally. This is the primary reason for the use of corporations. It is the oldest (several hundred years in the United Kingdom) and best form of "asset protection."

Second, incorporation separates the business from the owner's personal life. Your personal finances do not get mixed in with the business finances. This is an advantage.

Third, corporations provide additional flexibility and greater control. The owner may decide to reward an employee or business partner with a portion of the stock. With a corporation, provided that these decisions are properly documented, the owner may retain control by keeping the majority of the stock of the business. On the other hand, if the owner is in business without a corporation and then adds a "partner," a court may find that the owner has given away 1/2 of the business to this "partner." Worse still, both of the partners may be held personally liable for a debt of the business.

Recently we have seen advertisements on television for do-it-yourself corporations. Not surprisingly, we recommend against the do-it-yourself approach. The main reason why it is not a good idea for a nonlawyer to establish a corporation is that the nonlawyer may make a small technical mistake - which then voids the corporation. We have reviewed many do-it-yourself attempts that did not successfully form and maintain the corporation and were simply a waste of the owner's money. The Courts rarely give partial credit for a bungled attempt at incorporation.

If you have incorporated on your own, without legal advice, we recommend that you show your papers to a lawyer to obtain a professional opinion.

Edward X. Clinton, Jr.
Copyright 2010