Many small business owners incorporate because they believe that incorporating will protect their personal assets if they get sued. Unfortunately, however, when you are both the owner and one of the principal employees (or the only employee) in your small company, you often don’t gain much of a liability shield by incorporating. Here’s why:
Even though you, as a shareholder of your own corporation, may not be responsible for the debts of the corporation (since the corporation is a separate “person”), there is nothing to prevent someone from suing you personally for actions you performed. For instance, suppose you personally created an ad campaign for your corporation criticizing a competitor. The competitor views the campaign as malicious and untrue and decides to sue. They might sue your corporation and you, personally, as the creator of the ad. While you would not be liable for any settlement the corporation has to pay as a result of the suit, your personal assets could be attached to pay off any judgment the competitor won in its case against you the individual.
In addition, even though you might not technically be liable for the corporation’s debts, if you owned a very small corporation, chances are you would have to dig into your own personal bankroll to come up with the money to fight the lawsuit.
Thus incorporation does not necessarily prevent liability problems. One important step you can take to help protect your assets against loss is to obtain adequate liability insurance (business property, professional errors and omissions, and product liability).
The other fallacy about incorporation is that somehow it protects you from paying off any bad debts the corporation incurs. But things rarely work that way. While you are not automatically responsible for the corporation’s debts the way you would be responsible for your sole proprietorship or partnership debts, rarely will you be able to get a loan for a new small corporation unless you sign a personal guarantee, which means that you, personally, will have to pay back the loan if the corporation defaults. You may also have to sign personal guarantees on building or equipment lease agreements.
Although incorporation won’t necessarily protect your personal assets, there are good reasons for many businesses to incorporate.
Copyright 2020 by Janet Attard. All rights reserved.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.