Do you want to improve your business’ chances of succeeding? By taking the time to select the best legal form for your business you can improve your chances of growing your business and surviving through difficult times.
While cash is always important to a business, there are critical times when access to cash can make or break the business. One of these critical times is when a company is growing. A growing company needs cash to do things like purchase inventory, extend credit to new customers, and purchase additional equipment. Another critical time is when there is a difficult economy. During a recession, customers take longer to pay and inventory takes longer to sell. As a result, a company needs access to cash in order to continue making required payments to keep the business operating.
So how can your decision to set up a corporation versus a sole proprietorship improve your access to cash when you need it? It all relates to the differences between the types of organizations.
Life seems uncomplicated for a sole proprietor. A sole proprietorship begins whenever someone just starts a business in his or her own name. A small fee would be required if the owner is “doing business as” (dba) an assumed name. All of the earnings of the business are reported on the business owner’s individual tax return (Schedule C). In a “sole” proprietorship, the owner has 100% control of the business. Life is good… until the owner needs cash.
First of all, a sole proprietorship is very limited in the ways it can obtain cash. By definition, a sole proprietorship can’t raise funds by selling ownership in the business to someone else (as it can only have one owner). Unless the owner has a large amount of cash available, a loan is usually the only way for a sole proprietorship to obtain necessary funds.
But there are also characteristics of a proprietorship that can add to the difficulties of loans. A sole proprietorship does not outlive its owner. If the owner dies or decides to give up on the business, the business discontinues. A prudent lender would require collateral for the loan in case something happens to the owner. In a sole proprietorship, the owner is personally responsible for any losses. If the company fails, the owner would be held personally liable for the loan.
These characteristics promote investment in the corporation and improve the access to necessary funds when the company needs them.
The bad news is that there are costs which corporations have which proprietorships don’t have. First, there are costs related to incorporating. Depending on the state in which the business incorporates, it can cost between $50 and $350. If an attorney is involved, the costs are usually between $500 and $5,000. Also, filing and paying taxes will become more complicated so there will be additional annual expenses.
Evidence appears to show the benefits greatly outweigh the costs. Although the vast majority of businesses in the United States are sole proprietorships, most of the business earnings in this country come from corporations. Incorporating can help businesses grow through the difficult times.
While life may seem simple and uncomplicated for a sole proprietor, if you have big dreams for your business, incorporating will help you in the long run.