Benefits of Forming a Legal Entity
There are numerous reasons why you need to establish a legal entity from the beginning, but two main (legal) reasons are: 1) limited personal liability and 2) perpetual existence.
Protection Against Unlimited, Personal Liability
You expose yourself to potential unlimited liability without registering as a legal entity. If you register as a legal entity, the entity is considered the actor and is responsible when work is conducted by your business. If something goes wrong (e.g. someone slips in your store and breaks a bone or someone injuries themselves using your product) the entity is at risk. It is the entity that would be liable and not you as an individual.
On the other hand, if you do not establish a legal entity, by default you are considered a sole proprietor which does not afford the same protection as a legal entity. If you are a sole proprietor, you will be personally liable if something goes wrong and there is little to no protection of your personal assets if you are sued individually.
There are various types of legal entities, but the main legal entities are: 1) sole proprietor; 2) partnership; 3) limited liability company (LLC); and 4) corporation.
Moreover, forming a legal entity does not mean that you are immune to liability. For example, you will still be liable if you personally guarantee an agreement. Additionally, a court may determine that your legal entity was a sham and "pierce the corporate veil" exposing you to personal liability. Given these potential pitfalls, it is important that you discuss your legal entity and ensure you are following corporate formalities with an experienced lawyer.
Another major legal benefit to establishing a legal entity (such as a limited liability company or a corporation) is that these entities can be perpetual. A perpetual business means that the ownership can change even in the event of a member's death or retirement. This may seem like a small benefit; however, it can have a major impact on your business. For example, if a member dies in a non-perpetual business, a portion of the business would be treated as an asset of that member and potentially transfer to that member's estate. This may result in unintended or uninterested persons gaining access to company property or ownership.
If a business entity is perpetual, the company will continue to exist even after a member's death or retirement. This means that company assets will remain part of the legal entity and, pursuant to state statutes, governing of the company will transfer in an orderly fashion.