The advantages of incorporating
To incorporate or not? That is the question many self-employed workers and entrepreneurs starting a new business ask themselves.
Those still hesitant about incorporating their businesses should know that incorporating comes with many advantages. If you want to grow and hire people, a corporation is by far the preferable structure.
Incorporating offers several advantages over sole proprietorships.
- Owners benefit from limited liability
- Ownership interests are easier to transfer
- The life of the corporation can extend beyond that of the founders
- Credibility is boosted in the eyes of partners
- Financing and grants are easier to access
- Tax rates are lower
“It’s the very foundation of your business. 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,” says Aliya Ramji, a partner at McCarthy Tétrault and co-founder of MT>Ventures, a wholly owned division of the firm.
Below are the main advantages of incorporating for Canadian entrepreneurs.
Limited 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 toward the company’s creditors,” according to Aliya Ramji.
For example, shareholders in a corporation are not liable for the company’s debts. If the company goes bankrupt, shareholders are protected, while creditors’ recourse is normally limited to the assets owned by the company.
A creditor would therefore not be able to claim your personal property to pay off any debt unless you provided a personal guarantee. However, personal guarantees are still required by many banks.
|Pros and cons
Multiple owners whose ownership percentage is determined by how many shares they hold. There is typically lots of structure and formality in a publicly traded corporation, along with high administration costs.
Shared decision-making under the guidance of a board can hamper flexibility but it increases accountability and a company’s ability to raise capital.
Revenues, expenses and cash flow management are all tracked internally by professionals, with additional professional support from outside.
Publicly traded corporations must report their results publicly through audited financial statements and detailed disclosures.
Subject to progressive tax rates (the tax rate goes up as income increases) established by federal, provincial and municipal authorities.
Corporations have few limits on the expenses they can deduct for taxation purposes. They pay tax on earnings before tax at established rates. Net income that is distributed to owners is then taxed again at their personal rates.
Owners’ liability is limited to their investment. Capital can be raised without exposing owners to unlimited liability.
A corporation’s limited liability means that if the company is sued, personal assets of the owner or owners cannot be seized to settle the claims.
Easier ownership transfers
A corporation is a separate legal entity, and owners do not own its assets directly. Instead, they own shares in the corporation, which in turn owns the assets. This makes transferring ownership interests much easier.
This ability to transfer ownership makes it easier to attract investments. Venture capital firms and angel investors, for example, like to know they can get in and out of an investment on pre-agreed terms without delays caused by a muddled organizational structure.
The other key advantage that incorporated businesses have is that they benefit from a theoretically unlimited lifespan. When shareholders die, their shares are passed on to their heirs or are transferred via a sale.
Conversely, sole proprietorships automatically dissolve when their principals pass away.
Incorporating your business can provide an instant dose of credibility to your business. Potential investors, lenders, suppliers, customers and employees will immediately know that you are serious and thinking about the longer term.
That said, incorporating a business does require some additional cost and effort. A corporation needs to maintain a separate set of accounting records from those of its owners. Corporations must also pay annual registration fees and file separate financial statements and tax returns.
However, these inconveniences are worth the effort if your goal is to grow your business into a sustainable, long-term operation.
Improved access to capital and grants
“This mode of operation may also make it easier to raise capital and obtain grants,” says Laura Didyk, Vice President, Client Diversity.
“It can add credibility to your business which may make applying for financing or negotiating with a supplier easier,” notes Didyk, who oversees BDC’s strategy to support Canadian women entrepreneurs.
Corporations will also garner more attention from venture capital firms or angel investors who might be solicited to contribute to the company’s growth.
“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.
Lower tax rates
Incorporating also provides tax benefits, and corporations may pay less tax.
“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.
Provincial or federal incorporation?
Entrepreneurs can choose to incorporate their business in a provincial or federal jurisdiction, or both. The choice depends on the company’s own expansion plans.
“In general, the company will benefit from similar advantages whether incorporating provincially or federally,” says Yasmine Chaouni.
One factor to take into consideration while making this choice is the business’s expansion plan. If you operate a small business locally and don’t plan to expand or have national or international customers, it makes more sense to incorporate provincially.
Conversely, if you plan to expand your activities into other provinces or countries, then it is preferable to incorporate federally. “You will have the advantage of having the same name everywhere in Canada, as well as the flexibility to locate or move your business,” says Yasmine Chaouni.
Entrepreneurs should not hesitate to seek 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 being incorporated or protected against legal and financial liabilities. I should have talked to other entrepreneurs for advice,” says Ramji.
Looking back in hindsight, she believes that more women could learn from the approach 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 and incubator-accelerators, that are ready to assist them in their business endeavours.
Discover the steps to get your company up and running by reading Your ultimate guide to starting a business in Canada, where you will also be able to download our free business plan template.