Five-minute general counsel: should I incorporate?

People often ask about what entity they should choose for their new business, not knowing that the real first question is the one they skipped over without even realizing it. Should you incorporate?

Short answer: you should probably just buy insurance instead.

Entity types to consider include the corporation (with S- or C- taxation), limited liability companies (LLCs), partnerships, sole proprietors, and a few other entities with specialized application (such as the limited liability partnership for law firms).

The reason these entities exist is for limited *liability.*

The decision path to entity formation and selection should start with risk analysis and risk management. The two significant questions that you have to answer to decide whether this is the right course for you are: “What is my potential liability? and “What do I have to protect?”

What is your potential liability?

For example, if you’re going to be writing articles or conducting information research for corporate clients, then your primary risk is going to be from a generic commercial litigation issue. Based on the types of problems you’re most likely to encounter, errors and omissions insurance is the general type you would want to consider. If you are doing work where it is difficult to have lots of liability, either because it’s non-dangerous (e.g., designing websites) or you can contractually exclude much liability, then you’re almost certainly better served spending $500-$1000 a year on errors and omissions-type insurance.

If you are doing work where you can cause damages (anything dealing with people’s bodies or repairs to dangerous items), you definitely need to start with insurance and then look at your remaining liability exposure.

What’s your loss exposure?

Finally, if you’re just not that well-off, then spending an extra $1000 of time and effort and money to protect miniscule net worth might just not be worth it. If you have a home with equity and savings and retirement accounts, then, after you get sufficient insurance you can re-address this sort of question.

Once you’re properly insured (since not being sufficiently insured is one route to evaporating the limited liability protection you’re trying to establish by forming an LLC or other entity in the first place), then you can start analyzing the right entity for your purposes. If you’re going to be a single person in the business, then an LLC is usually the right place to start and end.

If your situation is different than the plain-vanilla model I described, then you should contact a lawyer with specific corporate experience. Your CPA doesn’t regularly address these issues of entity selection and may likely focus too much on the tax aspects, which is the wrong way to approach the issue (particularly since it’s easy to get the tax treatment you want these days with various entity types). Tax issues get addressed before you finally decide on an entity type.

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Since I’m a New York lawyer, I happened to notice someone in NY asking about LLCs:

With specific respect to NY LLCs, there is a publishing requirement that is just a pain in the neck, and so I recommend using a service to do the actual filings and publications. That is different from having them draft the actual LLC operating agreement, and any decent services would allow you to provide them with your own operating agreement. If you choose to do that piece yourself (again, only really a good idea if it’s just you in this business), then Nolo provides well-written guides.

2 Comments

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