Advantages of Incorporating (Series #1 out of 7)
#1.- Asset Protection. If you operate as a sole proprietor or partnership, there is virtually unlimited personal liability for business debts or lawsuits.
In other words should you go out of business or be a defendant in a lawsuit, your personal assets such as homes, investments, bank accounts, vehicles, etc. are up for grabs by the creditor's of the company.
This is generally NOT the case when you incorporate. When you incorporate you are only responsible for your investment in the corporation or another way of saying it, they can only get what the corporation owns. The limited liability feature of a corporation, while not a guarantee, is DEFINITELY one of the most attractive reasons for incorporating.
For those of you that have already incorporated, be aware that many lenders require you to personally guarantee a loan. By doing this you are basically taking the liability outside the corporation and the Corporation and you personally are liable for the debt. Obviously try to avoid signing personal guarantees.
There are also a few things a business owner can do to limit the reach of a personal guaranty. Here are some ideas:
a. Have Multiple Options
When looking to borrow, have multiple options. Some banks and other financial institutions, and some trade creditors, may be willing to limit the reach of a personal guaranty when competing for your business.
b. Limit the Exposure by Spreading Amongst Business Partners
You may want to ask the lender to limit your exposure under a personal guaranty to your percentage interest in the company. So, for example, if you have three owners and you each own 33.33% interest in the company, ask your lender to limit your liability under a personal guaranty to one-third of any claimed amount. Some lenders will accommodate such a request.
c. Spouse as Business Partner
Consider whether you want to include your spouse as a co-owner of your business. Banks and other lenders typically want all those with an ownership interest in the business to sign a personal guaranty when the business takes out a loan. (Some banks will waive the personal guaranty requirement if the business partner owns 20% or less in the company.) While there are many factors to consider, limiting a spouse’s exposure to business debts is an important goal.
d. Limit the Length of the Personal Guaranty
If you will be reducing the amount of the loan over time, you may want to ask your lender to consider limiting the personal guaranty to the first two or three years of the loan with the thought that your real estate or other assets which secure the loan will, at that point, provide adequate protection for repayment to the lender.
e. Avoid Self Renewing or Blanket Personal Guarantees
Often, when working with suppliers, a business owner may sign a personal guaranty at the start of the relationship without realizing that this personal guaranty will continue indefinitely or renew automatically. I recently reviewed a 12 year old guaranty which a trade creditor was asserting as a basis for personal liability. You may want to put a sunset date on a personal guaranty or negotiate with the trade creditor to eliminate or limit the reach of the personal guaranty after you have established yourself as a reliable borrower.
Personal guarantees are a reality with doing business. However, if presented with a guaranty, attempt to limit its scope and impact by requesting reasonable limitations.