Incorporate to protect yourself from the debts of your business, shriek the ads.
That’s the theory of incorporation: create a separate legal entity in the form of the corporation.
Let that entity incur debt and expose itself to other risks. If it fails, the personal holdings of the owners of the corporation are safe.
But, in the real world, most big ticket debts that a corporation might incur require the guarantee of the owner.
So if both corporation and owner are liable for the business debts, what has incorporation gained you?
You’ll be surprised.
Incorporate to protect the business
But, consider the same move, incorporation, for the opposite reason.
Incorporate to protect the business from the owner’s debts.
A sole proprietor and his business are one and the same in the law.
When the proprietor has a tax problem or there’s a judgment outstanding against him, all of the business cash and assets are exposed to that debt.
The business bank account can be levied for the owner’s back child support or a judgment against the owner for unpaid magazine subscriptions.
Most exemption laws found in state statutes protect some part of a wage earners salary. The working man needs some part of his paycheck to put food on the table and gas in the car.
But a proprietor isn’t an employee of his business: he and the business are one.
The debts of the businessman can put his business out of business.
Corporation immune to shareholder debts
It’s a different story if the business is owned and run by a corporation.
Get a job
Incorporating the business allows the business owner to create a distinction between the money necessary to run the business and the money necessary to feed his family. He can pay himself a salary, and leave the balance of the business assets in the corporation.
His salary is exposed to his debts, but not his livelihood.
The shareholder’s creditor can’t levy on the corporation’s bank account for the shareholder’s debt. The corporation is not liable for the debts of the shareholder.
So, by making himself the employee of his business, the business and its future is insulated from any financial troubles the shareholder has.
Knowledge workers too
It’s not just brick and mortar businesses that can use protection from its owners.
Realtor and consultants who are not incorporated expose their livelihoods to their creditors. Nothing is quite so devastating as having your clients served with legal process requiring them to pay the sheriff on your debts rather than paying you.
Incorporation is a powerful tool. It’s principal benefit is, however, just the opposite of the conventional thinking.
Image courtesy of Wikimedia.