of reacting forward, but she didn’t act on the advice. Even today, she still dreams of being her own boss but has yet to take action to start her own company.
Fred demonstrated the opposite reaction. He worked as a software engineer for a well-known company, and he was always coming up with interesting product ideas. Acting on my advice, he incorporated his best idea as a company, and every time he glanced at the corporate paperwork, he became more enthusiastic. He said to me, “I started to think that perhaps it was not such a crazy idea. At first, I tried to shake the idea out of my mind. Who was I to think I could run a company? Seeing the documents everywhere I went somehow made it seem less and less crazy, until I knew I had to do it. It got to the point where I knew I’d never be able to forgive myself if I didn’t try to do something with it. I know if I had not made the idea into a legal company, and kept reading the paperwork, I never would have had the confidence to try it out.”
Fred fleshed out a business plan during his spare time, and he asked one of his best clients for some feedback. Fred really just wanted reassurance, but the client loved the idea, and as chance would have it, he also had investor friends who were equally impressed. In the end, Fred was able to attract $5 million in investor funds, and he is now the CEO of his own company. When I saw him recently, his confidence astonished me. He still has no business training, but he rewired his way of thinking, and now he thinks and acts like a CEO.
This is what reacting forward can do: It builds the self-confidence to pursue our dreams. Once we take the first concrete steps down the path, and put ourselves in motion, it reinforces all the next steps we need to take.
Other Options for Reacting Forward
There can be other ways to move forward with your winning idea without incorporating. The simplest way is to just start conducting business. When you do that without incorporating, you are what’s called a sole proprietorship, which is the simplest and most common business structure. This refers to a business owned and run by one individual with no legal distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses, and liabilities. You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner, this status automatically comes from your business activities.
But like all businesses, you need to obtain the necessary licenses and permits, and regulations vary by industry, state, and locality.
A sole proprietorship, however, is legally vulnerable. As I discuss later, even sole proprietorships should take the step of incorporation, especially since the process is so simple and inexpensive.
You might also form a partnership agreement if you are going into business with one or more others, but again, this is risky without the legal protection afforded by incorporation. You will get some of the same psychological benefits by doing either of these, but I still always recommend that people incorporate their winning idea.
A winning idea is likely to require investors, manufacturers, suppliers, and other formally structured entities. These entities are typically incorporated businesses themselves, and for legal reasons, they can be restricted in working or contracting with unincorporated businesses.
The Practical Benefits of Incorporation
Still not convinced? Beyond the psychological benefits, how does incorporation help? Glad you asked.
As I say, when an idea is incorporated, it becomes its own legal business. This new business entity transforms the way the business is seen through the eyes of the law, and it often has more credibility with potential customers, vendors, employees, banks, and investors.
For instance, consider Google’s cofounders, Larry Page and Sergey Brin. For two years they ran Google without incorporating, since they didn’t see any need to and it was an expense they felt they could do without. Then one day Sun cofounder Andy Bechtolsheim decided he wanted to become an investor, but he wanted to invest in a company, not two guys. So Bechtolsheim wrote a $100,000 check to Google Inc., an entity that did not then exist, and handed it to Page and Brin, who got the message. On September 4, 1999, they filed for incorporation in California as Google Inc., opened a bank account in the newly established company’s name, and deposited Andy Bechtolsheim’s check.
Andy Bechtolsheim wasn’t teaching them a lesson in the power of reacting forward, since they were already working on the business. He was teaching them a lesson in common sense. With a sole proprietor or partnership, there is unlimited personal liability for business debts or lawsuits. That means if you went out of business, creditors could target your personal assets, such as your home or vehicle, as well as the personal assets of any investors who, by investing, become partners in the business. When you incorporate, you are responsible only for what you have invested in the corporation. That advantage alone is worth the few dollars it costs to incorporate.
Here are some other practical advantages to incorporation:
Legal Protection for a Purchaser
That asset protection is also important if you ever decide to sell your company. The purchaser of an incorporated business will not be personally liable if the seller did something unlawful, whereas if someone buys a sole proprietorship, they can be held liable for what happened in the past. Many successful small businesses are purchased by larger businesses, so the investment in the paperwork is essential to make that a smooth transaction.
Tax Savings
There are several tax advantages to incorporation. Your company becomes a distinct legal entity, even if it remains no more than just a file on your desk. That means that any business-related expenses, including some home-office operating costs, become tax deductible. Sole proprietors can deduct business-related expenses, too, but the benefit is often less. Sole proprietors report their business income on their own personal tax returns (Schedule C), and they also pay self-employment tax on the profit (Schedule SE), which at the time of writing is over 13 percent. In some cases, sole proprietors end up paying more in taxes due to self-employment taxes, and they are said to have some of the highest audit rates with the IRS.
Credibility
The abbreviation “Inc.” or “LLC” after your company’s name adds a touch of professionalism and credibility on any company stationery, especially with customers and lenders. Image is important, and customer confidence is tied to perceptions of your company.
The Simple Process of Incorporation
Incorporating a company is easy, takes only a few minutes, and costs less than a couple of hundred bucks. Costs and registration requirements can vary by state. However, dozens of online companies specialize in incorporation and have all this information, and the entire process can be completed by yourself online. Simply search in your browser “how to incorporate a company.”
Be aware that some companies, particularly larger outfits that advertise regularly on TV, will sting you with add-on services and unnecessary monthly-maintenance fees. Their online narrative is also designed to make the process sound complicated and fill you with fear so that you will hand over a bigger check. Don’t fall for this trick. Read the small print or avoid these firms. Seek out a company that makes the process transparent and effortless, since it absolutely should be.
Though filling out the forms is easy, incorporation does require you to make some initial, important decisions about your company. These require some advance consideration, which are as follows:
•Which state will you incorporate in?
•What is your company name?
•What type of corporation
