How to Know When it is Time to Incorporate a Business
For small- and medium-sized companies, the decision about whether or not to incorporate a business can be a difficult one. While incorporation has plenty of financial and legal advantages, it can also bring up many complex and, at times, costly issues. As the Globe and Mail reports, for businesses that are growing, the benefits of incorporation will likely eventually outweigh the drawbacks. However, to know when that point comes it is important to consider what those benefits and drawbacks are, especially in comparison to sole proprietorships and partnerships.
Advantages of business incorporation
Incorporation turns a business into a separate legal entity, meaning that shareholders and directors of that company – including the founder or former owner of the company – are not held personally liable for the debts the company has accrued. There are, however, exceptions to this rule, including personally guaranteed loans and payroll deductions. In general, however, the liability protections of incorporating a business are significant. In a sole proprietorship or partnership, by contrast, creditors may be able to come after a business owner’s personal assets. Furthermore, there are significant tax benefits to incorporation, such as the ability to potentially pay oneself a salary that does not place oneself in such a high tax bracket (as may be the case with a sole proprietorship or partnership). As the Canada Business Network points out, corporations also tend to have an easier time raising capital and their ownership is more easily transferable.
Disadvantages of business incorporation
In some situations, however, it can be more beneficial to structure a business as a sole proprietorship or partnership (or even, in limited circumstances, as a co-operative). Corporations, for example, are highly regulated and they require extensive records to be maintained. This layer of complexity can be a significant expense that may be too big of a burden for a small company. Furthermore, corporations are more complex and costly to set up than sole proprietorships and partnerships are. If a business is relatively small or has limited capital, then there may be few if any tax benefits to incorporation. Furthermore, conflicts can arise with shareholders and directors. Finally, most provinces in Canada have residency requirements for directors of corporations. If a director is unable to meet those requirements then he or she may be unable to work for that corporation.
Deciding how to structure a new or growing business is not always an easy decision. How a business is structured, however, will have major financial and legal ramifications. Business owners should seek out the advice of an experienced business law firm when contemplating any major change to their business. An experienced lawyer can assist business owners in understanding the benefits of incorporation versus other business structures and whether now may be the right time to incorporate their own business.