It’s quite common when people are looking to start their own business to wonder if you need to form an entity. The short answer is no, but the legal answer is yes. Have I lost you? There’s some gray area when it comes to not having an official business entity. Let’s discuss the business risks.
What Happens If You Don't Form a Business Entity
When you start a business, it is always recommended that you register your business. There are several reasons for this. But first, let’s talk about what happens if you don’t form an entity.
If you decide to start a business but do not actually register it, you are considered a sole proprietorship or sole trader. What this means is that you will need to use your personal social security number and your personal legal name to conduct business. This is a bit unorthodox, and many businesses will not want to work with you if they see it as unprofessional or lacking in credibility.
However, as long as you get all of your required licenses to conduct business and follow all of your tax requirements, running a sole proprietorship or sole trader is completely legal. Note that to stay legal, you will need to register your business with your state for tax purposes (you should always check the regulations and terms of your individual state).
The Risks When You Don't Register Your Business
Forgoing the route of actually registering your business does come with some negatives that could cause you to realize it may not be the best situation for you and your business both in the short-term and long-term. Below are some things you need to take into consideration so you understand the risks and liabilities involved in being a sole proprietorship or sole trader.
You Are Personally Liable for Everything
If you do not register your business and decide to move forward with a sole proprietorship or sole trader, you are essentially on the hook for everything. This means that if someone decides to sue you or you cause damage to property or bodily harm, you are 100% responsible for paying to settle those issues. It has been reported that 43 percent of small business owners have been threatened with or involved in a civil lawsuit.
If something happens to your business and someone sues you for $5 million and you don’t have the money, they’ll take your car, your home and anything they can to pay off the debt.
If you have zero protection, someone can take you to small claims court and actually sue you for not liking your product and claim fraud (especially if you don’t have a business license). In court, the fact that you didn’t register your business will not look good and could actually come back to bite you in the rear-end.
You Can Be Forced to Close Your Business
On top of not registering your business, you may also decide to forgo getting the proper licenses needed to conduct business legally. This could be on purpose or simply because you didn’t understand the benefits of starting an LLC instead of a sole proprietorship. Either way, this (if caught) could force you to close your business. And from there a few things can happen:
- You could reopen your business once you get the license(s) needed.
- You could be told you’re not allowed to ever reopen your business.
- You could be put on probation where you can’t reopen your business for a certain length of time.
The Benefits of Forming a Business Entity
When it comes down to it, it is in your best interest to register your business. With sites like Incfile, the process can be extremely easy, and filing fees are not expensive to form an entity.
The benefits of registering your business outweigh the risk. Once you register your business, you have a definitive separation between yourself and your business.
Protection of Personal Assets
The most important of all the benefits is the protection of your personal assets. Unlike the sole proprietorship or sole trader, if you get sued (for example), the individual cannot go after your personal assets such as your house, car, etc. Filing the paperwork to register your business protects against personal liability — this alone should give you peace of mind and the desire to register your business.
After moving forward and forming an entity, you can dedicate specific accounts to your business. That means a business checking account, business credit card and loan if needed. If you don’t register your business, a bank will not provide you with a business account.
Additionally, if you do not register your business, the chances of getting funding from investors (unless they are friends or family) are next to none. There’s way too much risk giving someone money who does not have a legitimate business entity.
Having separate accounts makes it much easier to see where money is coming from and where it is going. With just a personal checking account, you have to figure out what transactions were from the business and what transactions were from non-business sources.
In today's business world, branding means a lot. And when you register your business, you can brand your business name and help build attention and awareness as a legitimate business entity. This is especially important for marketing and advertising purposes. A logo means so much these days that not being able to market yourself to the fullest does you no good.
Think about brands like Nike, McDonald's and Apple to name a few. You don't even need to see the name of the business; you already know who they are based on their logo.
Forming an entity provides your clients and customers with a level of trust. Let me give you an example to think about.
If John Smith came to your house to give you a quote to remodel your home and he had no actual business or entity paperwork, no business insurance, wanted a check made out directly in his name and was wearing street clothes, would you trust him with $100,000 of your money to remodel your house?
Or would you feel more comfortable giving your money to Fantasy Home Remodeling Inc. who came in a polo with their business name on it, a vehicle wrapped with their logo, had quotes and paperwork with their business name on it and showed you their business insurance to prove they are a legit company? Probably the latter, right?
A sole proprietorship isn't always the most professional-looking business structure. In fact, a survey last year found that only 34 percent of consumers trust the brands they buy and use. Everyone is skeptical these days and if they don’t know you and aren’t comfortable, they are less likely to trust you and want to do business with you.
Ready to Start Your Business?
Running and operating an unregistered business is quite risky when you look at the big picture. The benefits of moving forward to register your business absolutely outweigh the risk of not registering at all.
Using a partner like Incfile means there is almost next to nothing you need to do to get up and running in no time. Incfile can do all of the form filing for you and provide guidance on each step to take.
And don't forget to check out our free Business Startup Guide. It will walk you through everything you need to know to start your business.