A separate entity can provide:
- Potential Tax Benefits - There are often significant tax savings that can be realized by setting up a separate entity. To begin with, it's simply easier to separate your deductible business expenses from your non-deductible personal expenses. But a properly-structured business can also result in significant savings on self-employment taxes and other business/income taxes. Everyone's situation is different, so talk to your CPA!
- Liability Protection - The owners and managers/directors of an LLC or corporation are not personally liable for certain company debts and liabilities, such as (a) company loans and credit cards (unless personally guaranteed); (b) acts of your employees that weren't your fault; and (c) acts of the other owners, managers, and directors. There are certain exceptions, but this liability protection generally means that your personal assets (your life savings, property, etc.) are not in jeopardy in the event of a debt or other liability of the LLC or corporation.
- Deal Certainty - With a separate entity and a good Operating Agreement (LLC) or Bylaws (Corporation), the owners and managers of your business all know what their deal is! No more wondering who's in charge, who owns what percentage of the business, etc.
- Legitimacy - People tend to see a separate entity such as an LLC or corporation as a more legitimate business than a sole proprietorship. It shows that you take your business seriously and have taken the right steps to protect yourself and your company.
So when should you form a separate entity?
- If you work alone and are the only owner – You don't need to form an entity the moment you have a great business idea or decide to start a new business. However, you should get your new entity formed as soon as possible, and at minimum before doing business with others.
- If you have business partners – Immediately. It's critical that you get your new business in place as soon as possible so that everyone involved understands their ownership percentages and management rights. This can greatly reduce the chance of arguments months or years down the road.