There are many reasons to incorporate a business. It can offer tax advantages, give your business more credibility, and help you secure business credit. These are great benefits, but the main reason why many sole traders decide to incorporate is to protect their personal assets from creditors.
Operating as a sole trader is a risky affair. Creditors can chase you for outstanding debts and if you cannot pay, your home and personal assets are at risk. The situation is very different if you operate a limited company or corporation.
Incorporating a business separates the business from your personal finances. When you pay a creditor, it isn’t your name on the check – it’s the business’s name. If something goes wrong and a creditor decides to sue you, you are not personally liable. However, whilst incorporation offers an extra layer of protection, there are still some situations where the corporate veil is pierced and you become liable.
Before you take the decision to incorporate, it is essential that you fully understand the piercing the corporate veil definition. Operating a company only protects you if you follow the rules. Pay close attention to the following key instances where the incorporation does not protect your assets. It could save you from a lot of future grief.
The Business Is Not Compliant
Businesses must remain compliant at all times. It is essential that you, amongst other things, maintain the correct paperwork, file your company accounts, correctly distribute company profits, and keep your personal finances separate from your business finances.
If it can be demonstrated that you have failed to follow strict corporate formalities, the corporate veil will be pierced.
Criminal Activities
Incorporation does not protect you if you break the law. If you commit a crime, you are personally liable for any debts you accrue. Criminal activity does not need to be something as dramatic as a Ponzi scheme; it can be something as minor as knowingly giving a lender the incorrect information when applying for a business loan.
Personal Guarantees
Running a small business can be tough, especially in the early days. You haven’t had time to establish a strong reputation, so suppliers and lenders may be reluctant to offer you credit.
There may come a time when you are asked to give a personal guarantee for a loan. On the face of it, this may sound OK but bear in mind that if for any reason, you can’t repay the loan, you are now personally liable for the debt.
Be Careful When Signing a Contract
As a business owner, you probably have to sign a million bits of paperwork, including contractual agreements. However, think very carefully before you sign your life away. If you mistakenly sign a contract or hire purchase agreement in your own name, you become personally liable for any debts. Don’t make this mistake! Always check that you have signed on behalf of the company, and it clearly states this on the agreement.
Incorporation will protect your personal assets, but only if you follow the rules.
