There are many reasons business owners choose to form a legal entity – whether a limited liability company, corporation, S-corporation or otherwise. The most important reason is that forming a legal entity reduces personal liability. Forming a legal entity also adds credibility and permits the business to grow. Plus, a legal entity permits the business to build its own credit. And ownership in the entity can be more easily transferred.
Limit Personal Liability. First, and foremost, forming a legal entity shields the owner(s) from personal liability for debts of the business and lawsuits against the company. So the existence of a legal entity protects the your personal assets such as your home, car, possessions, and savings. It does not, however, shield you against personal torts (injuries) that the owner commits on behalf of the entity. This limited liability is often referred to as the “corporate veil” because the owners of the company are protected behind it. It is very important, though, for business owners to understand that there are some limited situations where the corporate veil can be pierced to reach the personal assets of the business owners, such as where the owner co-mingles assets or does not abide by corporate formalities.
Grow Your Business, Now and Later. Second, forming a legal entity adds credibility to the business. Forming a legal entity communicates not only credibility but also permanence and prestige. The credibility that comes with forming a legal entity can also help your new business with potential customers, employees, vendors and partners. At the same time, it informs those same people that they are dealing with an entity and not you personally.
Build Buiness Credit. Third, because a legal entity – whether corporation or an LLC – is a separate entity, you are able to establish both a new and separate credit profile completely distinct from your own personal credit profile. Being able to establish business credit is especially advantageous for those who may have poor personal credit because it enables you to build a clear credit profile for the business. As a result, you may be able to receive loans, credit cards and credit lines that you might not be able to obtain as an individual, and eventually at better interest rates.
Transfer of Ownership. Corporation ownership can be easily transferable (with some restrictions on S corporations). Capital can be raised more easily through the sale of stock. Another advantage is that many banks prefer handling loans with incorporated borrowers. And while you can’t live forever—your corporation can. Even if an owner dies or sells interest, the corporation still exists.