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22 • 2012

Incorporate: Do It Right or Not At All

There’s no reason to incorporate other than liability protection.

That’s a bold statement, but it’s pretty much the case.  For some high earners, there might be some tax benefits, but incorporating is mostly about limiting your downside.  Because most new businesses fail, it’s a good idea to cover your downside risk.  The problem is that the majority of entrepreneurs think they’ve covered their downside risk, but they haven’t accomplished that goal at all.

If you are just looking for a structure with your partners, you could form a general partnership.  A general partnership agreement can include the business arrangement among founders very nicely.  Of course, there’s the problem of all of your assets being up for grabs  …. In a general partnership, each partner is 100% liable for the acts of the other partners, as well as for the business risks.

Who wants that?!!!

Well, that’s also the impact of not forming a corporation properly. Formed correctly, entrepreneurs can limit their liability to the assets of the business.  Formed incorrectly, you basically get nothing (except for an annual tab with the Franchise Tax Board).

In recent years, the do-it-yourself-download-forms-incorporate-online-now industry has given many the entrepreneurs the impression that you just need to jump online and file Articles with the Secretary of State.  That’s seems so easy that any smart person could do it, and that part of it is that easy.

But the age-old adage about things sounding too good to be true applies here in a really big way.  After all, you are asking Judges, Courts, and our entire judicial system to let you escape liability that your business incurs if things go wrong, so it makes sense that you would have to jump through some pretty big hoops for it all to work.  If you don’t jump through those hoops, you essentially get treated like a general partnership (i.e., a business structure with no liability protection).

So just what are those hoops?  There are essential two requirements for it all to work.  First, form the corporation correctly.  Second, maintain it correctly after it is formed.

Forming a corporation properly starts with reserving the name and filing Articles, but those are just the first steps.  Satisfying the steps for liability protection also requires preparing, qualifying and issuing shares; bylaws, organizational minutes, and other seriously important steps.  To learn more about exactly what it means to form a corporation properly, check out What It Means to Properly Form a Corporation. 

By the way, one thing that is not required is a pretty faux-leather corporate book and seal.  Don’t waste your money on that.  We live in the digital age, and corporate law recognizes that scanned documents are just fine.  Watch, Seal

Once formed, a corporation must also be properly maintained, for as long as the company is in business.  That’s right, if you don’t properly maintain a corporation (i.e., corporate minutes, Secretary of State filings), it doesn’t matter how much work you put into the formation, because it won’t protect you from liability.  To learn more about what’s involved, check out Corporate Minutes Stack the Deck in Favor of Asset Protection.

I wrote about how it isn’t necessary to incorporate to start a business, but if liability protection is important to you, it really doesn’t make sense to incorporate unless you plan on forming and maintaining the corporation in a way that will achieve what you are after.