Starting a business can help you attain financial freedom and allow you to become your own boss. However, not everyone is willing to sacrifice and face the challenges that come with starting and running a business.
One of the 1st things you’ll need to do when starting a small business is make it a separate entity. This is where incorporation comes into play.
Incorporating a business is 1 of the best ways to protect yourself because it creates a legal entity that's separate from its owner. Unlike sole proprietorship or partnerships, incorporation limits the personal liability of an owner against any business-related debts. This means that creditors can’t go after your personal assets—like your car or home—if your company goes bankrupt.
Below are some of the top mistakes entrepreneurs make when incorporating their small businesses.
This is 1 mistake that most people make without realizing it when incorporating their business. If your current employer conducted proper due diligence when drafting your employment contract, it’s likely that you signed a non-compete agreement that restricts your ability to start a competing business, especially if you offer similar products or services as your current employer.
Starting a new business without a thorough understanding of any agreements you have with your employer can be a risk to your business because it can open you up to lawsuits in the future. Be aware that your business will also be vulnerable if you use any resources, confidential information or intellectual property belonging to your current employer. It’s also not advisable to use your employer’s phones, computers or internet to conduct any aspect of your business.
It’s important to understand the differences that exist between C corps and S corps when incorporating your small business. The type of corporate structure you select for your business will have both tax and ownership repercussions. You may find yourself in a situation where your income is taxed twice, or you could even lose control of your company to other investors.
It’s wise to work hand in hand with an experienced business lawyer throughout the incorporation process. This will help you avoid unnecessary mistakes that could leave you vulnerable to potential lawsuits.
Do you live in a state like California, where corporate income tax is sky high? Incorporating your small business in a different state to benefit from their zero percent tax rate may seem a great way to save money, but the law doesn’t take into account where your business was established or incorporated.
When it comes to the tax burden, the law only considers where the business owner lives and where the business operates. Although larger corporations have more flexibility to pick and choose which state they’d like to incorporate their business, small businesses should incorporate in the state where the business owner lives to avoid potential lawsuits and tax audits.
You need to do a lot of research before incorporating your small business. This will help ensure you don’t select a business name that’s already been incorporated locally or within another state.
A name can also be in conflict with common law rights of other existing companies, federal trademark filings, professional fictitious business name filings or state entity filings. It’s possible that the name you chose could also be an illegal corporate name for your profession—so doing your research before selecting a name is a must.
You want to avoid any situation that could force you to rebrand your entire company down the road simply because you didn’t check for any applicable legal issues with name usage.
Incorporating a business doesn’t make it immune to local business regulations. Unfortunately, it often takes time before businesses realize they’re not in compliance with local municipality ordinances.
Failing to comply with local ordinances can cost your business thousands of dollars in fines, penalties and back taxes. Because of this, it’s a good idea to consult a local expert who’s experienced in establishing corporations in your community.
It’s true that incorporating helps protect your personal assets from business liabilities. But the truth is that starting with insufficient capital can still hurt you financially. Some courts will find ways of bypassing the protection laws to hold a company owner personally liable in certain situations.
You should consider hiring a professional accountant to help you understand the minimum amount of assets, revenues, insurance and capital required to properly cover your liabilities. Minimum capitals will vary greatly depending on the type of industry or business you’re undertaking.
There’s a lot of documentation involved when incorporating a business. Some of this documentation may take a lot of your time and resources. Although you may be able to start running some aspects of your business without certain documents, don’t be tempted to neglect filing all required documents before starting your operations. Taking shortcuts early on often creates unnecessary headaches down the road.