Doing business without incorporation is like having sex without protection. You open yourself up to all sorts of risks.
Why You Should Incorporate
Last week I ran into an entrepreneur that I had met at a few events. He explained to me that he and his business partner wanted to do more customer development before they formed a ‘real company’ and went after funding. “We don’t even really know what we are building yet.” Mind you, this gentleman already had paying customers. He just didn’t know if the product the customers were paying for would be his end product. Additionally, his current product was also being used by his clients to make critical internal decisions.
This is what is wrong with the entrepreneur's thinking.
We are not a real company.
You are a company; you are just a company that is unprotected. Registering with the State is not a magical portal that makes you a ‘real company’ in the eyes of the law or government. The second you ‘do’ business, for example have customers (paying or not), in the eyes of the law and government you are a business.
Forming a corporation is only for going after funding (or opening a bank account)
Granted you should be a corporation when you go after funding (Footnote 1). Being a corporation is not simply a hoop you have to jump through for investors it is for your personal protection. If you are not an LLC, LLP, Corporation (S, C or B) and you are ‘doing business’; if someone sues you they can take your personal property. Your car is now their car. Your home? It is now their home. Your money in your personal bank account, yup, you guessed it, it’s theirs.
Incorporation allows you to protect your personal assets by giving you a shield of limited liability. When you incorporate the law creates a fictional person called your Company. That fictional person is the one who is doing business. The fictional person is signing contracts, taking on loans and investment money, and collecting money from customers (Footnote 2). Because the business is viewed as being a person separate from you if there is a lawsuit the only thing the person suing you can typically collect are the assets that belong to the fictional person, the Company. However, if you are doing business without this 'limited liability' there is no fictional person to protect you. Now your customers, vendors and other effected by your business can go after your personal property as payment.
Now that I have scared you let me also provide you with a counter argument.
There is some logic behind waiting a small amount of time before you form a corporation. If you really are still just doing customer development, you are polling people about an idea, trying to figure out if this idea really is disruptive; it might make sense to wait a little before you rush towards incorporation. However, if you have a team of people there needs to be an agreement between you all about ownership of IP, ownership of the business, etc while you are working together. A gentleman’s agreement will not suffice for these…remember SKYPE© (Footnote 3). Once you have left this zone and you are certain you want to go forward with the idea you need to incorporate.
My advice to the entrepreneur I talked to was to incorporate. Each person situation is different and you should seek legal consul to determine what the best decision is for you.
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Footnote 1: We will talk about the different forms of business entries and the benefit of being a Corporation verses other forms when you are seeking funding. Spoiler Alert!!! I favor forming a C-Corp.
Footnote 2: There are some exceptions to this rule. If it is seen by the court that your company is simply a shell company then your personal assets can be attacked through something called Piercing the Corporate Veil.
Footnote 3: I often use Skype’s legal woes as a parable and a warning to entrepreneurs. They will be used later on as a case study about why IP assignments are important.
