Congratulations on the idea of starting a business! You will not be alone. You will be joining over 32.5 million small businesses (as of the year 2022) that represent 99.9% of all U.S. businesses. (See https://www.chamberofcommerce.org/small-business-statistics.)
You likely heard that you need to incorporate before starting a business. My immediate thoughts: “Hmm. Interesting advice. Tell me why?” Your likely response (i.e., possibly gained from textbooks, news articles, or conversations you have had with others) is that you want to protect yourself from lawsuits or creditors. Well, lawsuits can be filed irrespective of their merits and operating as a corporation will not prevent a sue-happy customer or client from filing one against the corporation and you, individually, as its owner. Also, if you fail to follow the state laws regarding the formation and operation of a corporation you may not gain the potential benefit of shielding your personal assets from the reach of aggrieved customers or clients.
Did you know that there are several types of business entities (i.e., a corporation being one of many business entities)? (See https://www.sba.gov/business-guide/launch-your-business/choose-business-structure.) Note the business entities listed within the linked article’s table under the “Liability” column. There are several types of corporations that will meet your initial objective of not subjecting your personal assets to successfully litigated business lawsuits (i.e., provided all aspects of creating a business entity and operating a business correctly are followed). However, there are other types of business entities that can help you reach this same objective, some of which are listed within the referenced article’s table. Which one is right for you? Looking further within the referenced table, answering additional questions such as ownership, liability, and tax objectives when selecting a business entity may help narrow your options for selecting the most beneficial business entity for your anticipated venture.
What personal assets do you own (not lease) that you want to protect from a lawsuit? If you own substantial assets (i.e., known in some circles as someone with “deep pockets”) that may be open to creditors of a failed business or an injured customer, then you are likely a good candidate to establish a business entity prior to offering business-related products or services to customers and clients. However, if you don’t own substantial assets outright (i.e., rent a home, lease a car, highly leverage assets resulting in little to no equity (value) in them, hold value in qualified retirement plans (i.e., 401k plan, 403b plan, etc.) protected from most creditors by federal laws, etc.) then you may not be a good candidate, initially, for establishing a business entity prior to operating as a business. Individuals without any substantial assets or have levered their assets leaving very little equity in them are colloquially known as “judgment-proof defendants.” These individuals offer little incentive for a contemplating plaintiff to file a lawsuit (i.e., a successful plaintiff may win the lawsuit but discover the defendant has little value in their assets for them to attach and liquidate). In fact, the time and money a plaintiff may spend to successfully bring a lawsuit (i.e., attorney fees, investigation expenses, court costs, etc.) against a judgment-proof defendant could be more than what they receive from the defendant.
As the above Q&A highlights, the answer to the initial question “Do I need to incorporate before starting my business?” is “It depends.” Some of the factors an attorney will weigh to answer the question for you include the following: i) the state law governing the type of business you are considering (i.e., do certain business activities require a particular type of business entity?), ii) the business environment of the state and locality you wish to do business, iii) the legal environment of the state and locality you do business in (i.e., do the courts tend to favor business owners or injured plaintiffs?), iv) the types of assets you own (i.e., do you have assets that are exposed to successful plaintiffs such as individually-owned banking accounts and brokerage accounts?), v) whether you intend to do business in more than one state (i.e., each state may require a business to file forms identifying the business, its owners, and its representatives, etc.), etc. So, now you know that the answer to the initial question requires a lot of inquiry by an attorney and much reflection and business judgment by you to reach the best answer.
NOTICE AND DISCLAIMER. FOR EDUCATIONAL PURPOSES ONLY. Not an advertisement for legal services. The author of this article does NOT actively practice law; therefore, no attorney-client relationship has been, nor will be, established from this educational article. The information contained herein is for general informational purposes only, does not reflect the current law in any state, does not constitute nor should be considered legal advice, nor is it intended to be a substitute for legal counsel on any subject matter. Do not act or refrain from acting based on anything you read in this article. Furthermore, the information contained herein is presented without any representation or warranty whatsoever, including as to the accuracy or completeness of the information. The author of this content assumes no liability or responsibility for any errors or omissions in the content and reserves the right to change the content from time to time. The author is not responsible for any third-party content that may be accessed through the article and any links to third-party content are provided for your convenience. Please seek the advice and counsel of an attorney licensed in good standing with the state where you would like to do business in.
