Week 1: Should I form an entity?

Time to get going on our agenda. Congratulations! You have a business idea. Or you are already operating. You might be a designer, a coach, a maker, a consultant, a builder, a tutor, an architect, own a restaurant, or a string of local coffee houses. No matter what your business is, the first question I will ask you as a new client (after we get the engagement letter signed), is whether you have formed an entity for the business to operate under? Today we will discuss why I think doing this is important.

With a few notable exceptions, I am a big proponent of forming a business entity that provides limited liability protection under state law. This is because (as I will go into in greater detail later) I think that business owners should take every step they can to protect their personal assets from business creditors and potential lawsuits.

The main question you should be asking yourself is: do I have personal assets (house, car, college savings, regular savings, brokerage account, etc) that I wouldn't want to have to liquidate if I were sued and lost or if my business went under? If the answer is yes, you should know that you are putting those assets at risk by operating your business as a sole proprietor (without forming an entity).

In addition, operating your business under the aegis of a business entity will legitimize your business in both the eyes of your clients and customers and yourself.

In what situations would I not form a limited liability entity of some sort?

1.     If you do not expect your business to be at all profitable I would not form an entity. I would go back to the drawing board and ask yourself exactly what you are doing and why you are looking to form a business that is going to be losing money. Of course, it’s normal for some businesses to lose money as they ramp up, but the end game and the business plan should aim for profitability.

2.     If you are in the planning phases, and you are really not ready to start operating or spending ANY money on planning expenses for the foreseeable future, I might wait until you are ready to devote resources to your business idea.

Other than these 2 reasons, I see little benefit in operating without the limited liability protection that entities provide to businesses who operate under them. A limited liability company, for example, with all its attendant parts (more on this later) costs around $500 to form with a local attorney (in Vermont)- including the filing fees. In the scheme of things, this is not a lot of money to obtain protection from business law suits and creditors.  But we will talk about that in our next post.