When starting a new venture, an often cited question of many entrepreneurs is whether to incorporate their venture, or to operate their venture as either a sole proprietorship or a general partnership. This article will consider three non-exhaustive factors (limited vs. unlimited liability, taxes, and succession), which entrepreneurs can and should consider when deciding which of the aforementioned business vehicles to use in respect of their ventures.
Limited vs. Unlimited Liability
In deciding whether to incorporate, an entrepreneur must consider the amount of personal risk and liability he or she is willing to incur. Entities, such as general partnerships and sole proprietorships, are unlimited liability business vehicles, meaning that proprietors can be sued personally if their venture incurs liability. Conversely, corporations are limited liability business vehicles, meaning that, save for a few exceptions, proprietors’ liability is limited to their investment in the corporation. Accordingly, entrepreneurs operating in industries with significant liabilities are well-advised to incorporate in order to reduce their personal exposure to risk.
It is a common myth that corporations always incur less tax than sole proprietorships or partnerships. While the corporate tax rate is lower than the marginal tax rate for high- income earners, determining the tax ramifications for a corporation, compared to that of a sole proprietorship or partnership, involves a more nuanced approach than looking strictly at the differentials in tax rates. In deciding whether a corporation is the most tax-efficient business vehicle, proprietors must look at their circumstances, including family income, as well as the projected profit of the venture in its initial years. As a result, if a proprietor has little to no income, or if the proprietor is a high-income earner and expects their business to operate at a loss for several years, then (from a strictly tax-based perspective) it may make sense for the proprietor to wait to incorporate their venture.
Proprietors should also consider what they want to happen to their business once they pass on. Sole proprietorships and two-person partnerships presumptively end once a proprietor passes away, and a partnership of more than two partners is presumptively dissolved as between the dead partner and the other partners. Accordingly, the deceased proprietor’s family will generally have no interest in the venture upon the proprietor’s death. Conversely, since corporations are separate legal entities, they exist beyond the life of the proprietor. Upon death, the proprietor’s shares in the corporation are distributed through his or her estate, allowing beneficiaries thereof to receive the shares and continue the corporation.
The decision to incorporate, or to operate as a partnership or sole proprietorship, involves the consideration of many interwoven factors. These factors are nuanced, and often require input from trusted professionals. Accordingly, if you require assistance in deciding whether to incorporate, or require legal assistance in matters with respect to your venture, please do not hesitate to contact the writer.