Why Should a Business Incorporate?
An employee negligently overlooks water on the floor of your office or warehouse causing a client or customer to slip and sustain severe injuries. The customer wins a large judgment against you because you are the owner and employer. Not a nice thought, right? What can you do to protect yourself in such a case?
As owner/employer, you want to avoid paying the judgment with your personal funds should there not be enough money in your business accounts. You want to shield your personal assets, such as your home, personal savings accounts and other personal property and investments. To do this, you must limit your liability.
If a business asset such as a delivery truck or car is involved in an accident that causes the death of someone, then your personal assets should be shielded from the responsibility of paying damages for such an accident. It can certainly be argued if damages are caused by a business activity, then only the business assets should be used to pay or correct the damages. Since the early 1800's, however, the Louisiana Civil Code has provided that "all of a person's property is the common pledge of all of his creditors." This means that everything you own may be seized by creditors to satisfy debts owed.
You are responsible if an employee causes serious financial damages to another party. If your business is operated as a sole proprietorship, a plaintiff could seize personal as well as business assets to satisfy a judgment. Or, if your business is not incorporated and it fails, all of the unpaid creditors remaining when the doors are finally closed can force payment out of your personal assets.
What is the shield to protect your personal assets from the effects of the Civil Code? It is corporate personality, becoming a corporate or limited liability entity to own and conduct your business enterprise.
The formation of a corporation or limited liability company will insulate your personal assets from the grasp of a business creditor or someone who wins a lawsuit against the business, because once properly formed the law recognizes the corporation as a "person." The law actually treats a corporate entity as a separate and distinct person — a legal personality completely different from you.
Although a fictitious person in the sense that it is not a natural person, a corporation is deemed by the law to have the same legal personality as natural persons. This grant of legal personality means a corporation has its own rights and duties, with its own distinct assets and liabilities, all separate from the assets and liabilities of its stockholders.
For example, as owner of an incorporated business, you have the legitimate means of personally drawing profits from your business. Profits may be drawn via payroll or dividends. You may be the sole stockholder as well as an employee. You are entitled to a salary for your labors as an employee, and also entitled to receive dividends on your stock as a shareholder. Yet, should the corporation become unable to pay its debts, the personal assets received from the corporation are shielded from the creditors of the corporation. Only assets that are in the name of the corporation may be seized by its creditors. And, when all those assets are gone, there is nothing creditors can do.
The most convenient time to form a limited liability company or to incorporate is at the start of a business venture. However, a business started as a sole proprietorship can be turned into a corporation at any later point. Regardless of when you decide to incorporate your business, you should speak with an attorney. You should also consult with a certified public accountant. He or she will have suggestions to assist in avoiding unwanted tax consequences during the course of incorporating the business.
Incorporating a business enterprise, or organizing it as a limited liability company, can be critically important — since this one business decision could preserve personal assets you may have spent two or more decades accumulating. Is whether or not to incorporate your business really a question?
Republished | Originally published on July 1, 1993
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Disclaimer: This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.