The advantages of incorporating
To incorporate or not? That is the question many entrepreneurs and self-employed people ask themselves. Are you one of them?
What is incorporation?
Setting up a business is commonly called incorporation.
Incorporating involves registering a business in the legal form of a corporation (also called “company”). The business then becomes a corporation, that is, a separate legal entity from its owners. This allows it to own assets and incur debt.
If you want to grow and hire people, a corporation is often the most suitable structure. A corporation may have only one shareholder, while a large publicly traded corporation may have thousands.
Why should you incorporate?
Incorporating offers advantages over sole proprietorships. It allows you to:
- Limit your personal liability
- Facilitate financing
- Ensure the longevity of your business
- Immediately boost your credibility
- Get improved access to capital and grants
- Lower your tax rate
Aliya Ramji, a partner at McCarthy Tétrault and co-founder of MT>Ventures, notes that “The right legal form for your business is crucial. Once you’ve laid the groundwork, it will be easier for you to determine how and where you’re going to grow your business and identify the most cost-effective ways to succeed.”
Below are the main advantages of incorporating for Canadian entrepreneurs.
1. Limit your personal liability
A corporation is a separate legal entity from its owners. It has “the major advantage of limiting the personal liability of its directors regarding the company’s debt,” notes Ramji.
For example, shareholders in a corporation are not liable for the company’s debts. If it goes bankrupt, debt collection is normally limited to the assets owned by the company. Shareholders are protected.
You cannot therefore be held personally liable for the company’s debts unless you provided a personal guarantee. However, such guarantees are still required by many banks.
Several of the corporation’s characteristics limit the personal liability of shareholders. The following table presents the main implications for shareholders.
| Characteristics of the corporation | Implications | |
|---|---|---|
| Legal |
The company is a separate legal entity from its owners. The owners are shareholders of the company. Their liability is limited to their investment. The company uses capital without exposing the shareholders to unlimited liability. |
A corporation’s limited liability means that if the company is sued, the owners’ personal assets cannot typically be seized to settle the claims. |
| Control |
The company usually has several shareholders. Their interest is usually determined by how many shares they hold. The company is led by a board of directors elected by the shareholders. |
The board of directors’ decisions are voted on by the shareholders. This decision sharing can limit flexibility. However, it increases accountability and a company’s ability to raise capital. Some companies are publicly traded. They are typically very structured and formal and have high administration costs. |
| Accounting | Revenues, expenses and cash flow management are all tracked internally by specialists, with external professional support. | Publicly traded corporations must present financial statements audited by a chartered professional accountant (CPA). |
| Taxation |
he corporation is taxed at progressive rates, meaning that the tax rate goes up as income increases. Federal, provincial and municipal authorities establish the rates. |
Corporations have few limits on the expenses they can deduct for taxation purposes. They pay tax on earnings before tax at established rates. |
| Earnings | Earned by the corporation. Dividends may be paid to shareholders and/or retained in the corporation. | Dividends paid to shareholders are considered revenue for shareholders, and they are generally taxed again. |
2. Facilitate financing
A corporation is a separate legal entity, and owners do not own its assets directly. Instead, owners hold shares in the corporation, which in turn owns the assets.
A corporation may, with the required approvals, borrow money and issues shares and debt to obtain financing.
In addition, venture capital firms and angel investors, for example, like to know they can purchase or sell an investment on pre-determined terms without delays caused by a muddled organizational structure.
3. Ensure the longevity of your business
Another key advantage of companies is that they benefit from a theoretically unlimited lifespan. When shareholders die, their shares are passed on or sold and the company survives them.
Conversely, sole proprietorships automatically dissolve when their owners pass away.
4. Immediately boost your credibility
Incorporating your business can provide an instant dose of credibility. Your business partners immediately know that you are serious and have a long-term vision.
That said, incorporating a business does require some additional cost and effort. A company must:
- maintain a separate set of accounting records from those of its owners.
- pay annual registration fees.
- file separate financial statements and tax returns.
These inconveniences are worth the effort, however, if you want your business to be a sustainable, long-term operation.
5. Get improved access to capital and grants
“This legal form may also make it easier to raise capital and obtain grants,” says Laura Didyk, Senior Vice President, Prairies, at BDC
“It can add credibility to your business, which may make it easier to get financing or to negotiate with a supplier,” notes Didyk.
Corporations will also be more attractive to venture capital firms or angel investors who might be solicited to finance the company’s growth.
In addition, “the Canadian government offers a number of loan and grant programs that are open only to incorporated businesses,” says Yasmine Chaouni, a manager with Corporations Canada, Canada’s federal corporate regulator.
6. Lower your tax rate
Incorporating also provides tax benefits, as corporations may pay lower taxes.
“Corporate tax rates are generally lower than personal income tax rates,” explains Stefanie Ricchio, a chartered professional accountant (CPA) and founder of the consulting firm The Modern Accountant.
Should you choose provincial or federal incorporation?
Entrepreneurs can incorporate their business in a provincial or federal jurisdiction, or both. Regardless, “the company will benefit from the same advantages,” says Chaouni.
The choice depends on your expansion plans. For example, you could incorporate provincially if you have a small local business and don’t plan to expand or have national or international customers.
Your business will be subject to a different law depending on the province or territory in which you register it.
Conversely, if you plan to expand your activities into other provinces or countries, then you should incorporate federally.
Thus, “You will have the advantage of having the same name everywhere in Canada, as well as the flexibility to move your business anywhere in the country,” says Chaouni.
Don’t hesitate to seek advice
You shouldn’t hesitate to get advice from other business leaders to learn more about the benefits and costs of incorporating a business.
“I owned a business for five years without incorporating it or protecting myself against legal and financial obligations. I should have asked other entrepreneurs for advice,” says Ramji. She adds that more women should follow the example of male entrepreneurs. “Men tend to be more inclined to network and tell others about their business,” she says.
Entrepreneurs can also draw on a vast network of resources, such as:
- chambers of commerce
- government economic development agencies
- incubator-accelerators
These resources assist them in their business endeavours.
Next step
Discover the steps to get your company up and running. Read our guide to starting a business in Canada.