One of the most frequent questions asked by people wanting to start or grow their small business is "should I incorporate?". Operating a through a corporation provides several significant advantages to small business owners, but that doesn't mean it's right for everyone. Before you decide to incorporate, it's worthwhile to consider the potential benefits of incorporation as well as the down sides.
Potential benefits of incorporating include:
1. Protection of personal assets.A corporation is a separate and distinct legal entity. It's treated as a person in law and as such, it can own property, borrow money, carry on business and sue or be sued. By carrying on business through a corporation, the corporation's owners can avoid potential liabilities that they would incur by carrying on business directly. This is one of the main benefits of carrying on business through a corporation. This protection from liability can be limited if:
- The shareholders (owners) of a corporation fail to treat the corporation as a separate legal entity and to ensure that all customers, clients, etc. are aware that they are dealing with the corporation and are not contracting with individuals;
- The shareholders grant guarantees or other security on behalf of the corporation;
- The shareholders also act as a director of a corporation, in which case the shareholders can be liable for acts or omissions in their role as directors.
2. Potential tax savings.Carrying on a business through a corporation, rather than personally, can present opportunities for potential tax savings, including:
- splitting income between shareholders (recent changes to the Income Tax Act have reduced the effectiveness of income splitting for some shareholders and corporations);
- utilizing the federal small business deduction limit;
- deferring tax on some of the money that you make until it is withdrawn from the corporation; and
- use of the lifetime capital gains exemption on the sale of the business.
3. Name protection.Registering a named corporation provides protection against others using an identical or nearly identical name for their corporation. This protection is limited to the jurisdiction in which the business has been registered and doesn't provide as much protection as a registered trademark, however, it does provide some benefit.
4. Easier access to financing.A corporation can obtain traditional bank financing, just like a person. Some banks prefer lending to a corporation rather than individuals. A corporation can also raise capital by selling its shares for money, however, the sale of shares by private corporations is restricted. Caution must be taken to ensure that any sale of shares is done correctly and in compliance with the applicable securities regulations. We strongly recommend speaking with a lawyer BEFORE issuing or agreeing to issue shares of a private corporation.
5. Increased credibility in the marketplace.Many people consider corporations to be more credible than an individual carrying on business under their own name. This can be important for sales purposes as well as securing contracts with suppliers, banks, distributors, etc. Using a corporate name can also make it easier to establish your brand name. When was the last time you dealt with a large business that was operated by an individual under their own name?
6. Continued existence.A corporation continues its existence continues until it has been dissolved. It can be transferred at any time to one or more new owners, and continues even after the death of its shareholders. If the shares of the corporation are sold in the future (or shares are transferred as a result of death), the new owners will be able to continue on the business of the corporation as though no changes have occurred. All of the corporation's contracts, licenses, receivables, etc. will remain in place. This can save considerable time and expense if the business is transferred.
Potential downsides of incorporating include:
1. Added costs.There is a one time cost for incorporating a company. There are also annual costs associated with maintaining your registration, including legal and accounting fees.
2. Loss of personal tax benefits.In some cases, tax benefits that were available to you as an unincorporated business may not be available to your corporation. Speak with your accountant for further information in this regard.
3. Additional paperwork.Running a business through an incorporated entity will require additional paperwork, including but not limited to yearly tax returns and annual resolutions of the directors and shareholders. If you purchase our corporate law services (included as part of our ALL IN incorporation package), we'll take care of some of your legal paperwork for the first year, allowing you to spend more time on growing your business.
4. Banks may require personal security.If your corporation has few assets, a bank providing loans to the corporation may require its shareholders to provide personal guarantees or security for the benefit of the bank. To the extent that you provide personal guarantees or security, your protection from liability as against the lender will be lost.
"Should I incorporate" is a question that should only be answered after taking into consideration each of the advantages and disadvantages listed above.
If you'd like more information about whether or not you should incorporate a company, click on the Free Consultation button below to set up a call with one of our business lawyers.
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