You have made the decision to be the entrepreneur you have always wanted to be, to start up your business and make your fortune. Congratulations!!! But now what? You are so excited but now all of these questions about how you want to form and run your business are weighing you down and creating endless confusion and anxiety.
One of the first questions is whether you should incorporate your business or not. In this blog, we will address the advantages and disadvantages of incorporation.
Check out Part 1: Sole Proprietorships- https://azperlegal.com/blog/part-i-sole-proprietorships/
Advantages To Incorporating
1. Your startup is separate from you
By incorporating, your startup business becomes a legal entity separate and apart from yourself (from the individual owner or owners). A corporation (the legal entity) has the same rights and obligations as an individual – it can borrow, it can negotiate, it can enter into contracts, it can sue and it can be sued. The corporation’s money belongs to the corporation; not to the shareholders/owners (that means you – you are shareholder!). It can pay shareholders dividends, etc. but the shareholder cannot simply “take” money from the corporation.
2. Added protection against legal liability
There are legal ramifications and advantages to incorporation as well. By incorporating, you limit the legal liability of the shareholders (owners) of the corporation. The corporation can be sued; the shareholders cannot. The only exemption is when you, as a shareholder, sign a personal guarantee on behalf of the corporation.
Directors are also protected from legal liability with the exception of outstanding tax obligations or payroll deductions. The shareholders are not responsible for the debt of the corporation; creditors cannot pursue shareholders for the corporation’s debt.
This means that your personal assets are protected from any legal liability incurred by the corporation.
3. Tax Advantages
There are certain tax benefits to incorporating as well. Corporations have tax flexibility – they generally have a lower tax rate than do individuals carrying on business as sole proprietors and this has implications for when a company starts to grow. Corporations are also taxed separately; remember, it is a separate legal entity with the same rights and obligations that are attached to individuals.
You have greater flexibility in how you wish to pay yourself – by salary, bonus, management fees, dividends, or a combination thereof which can minimize the tax implications for the corporation and for you.
A corporation has greater access to capital and grants – it is easier to raise money if the company is incorporated. You can issue bonds or share certificates to investors – sole proprietors have to rely on their own money or loans for capital. Corporations can also typically borrow at lower rates of interest than sole proprietors. After revenues reach a certain point, i.e. $30,000.00 and above, it is more fiscally advantageous to incorporate. And that is the whole point of a company – you wish it to grow, become self-sustaining and eventually turn a profit! This is where incorporating becomes essential, particularly with regard to tax implications and limiting legal liability.
The Drawbacks To Incorporation
1. Start-Up Costs and Administrative Work
Right off the bat, the initial startup costs to incorporate are a little more, however, the long term gain outweighs the short term expense. Once a business is incorporated, there are numerous requirements under the Business Corporations Act. A corporation must:
- maintain an up to date Minute Book which includes its Articles of Incorporation,
- maintain and file Annual Returns and Resolutions (annual returns are different from annual corporate tax returns)
- maintain and file any changes in the corporation (i.e. address, directors, etc.)
- amend the Articles of Incorporation if the structure or name of the corporation is changed
- “paper” major decisions of the corporation by drafting Directors’ and Shareholders’ Resolutions – i.e. if you wish to issue shares to family members if you wish to add your spouse or adult child as a director or officer, etc.
- File corporate tax returns
2. More Complex Business Structure
A corporation has a more formal and organized business structure. Corporations are governed by the Business Corporations Act and must adhere to the legislated requirements for a business organization. There are three levels of business organization to a corporation, as follows:
- Shareholders – Shareholders own shares in the corporation – they make decisions by voting and passing “resolutions” – these are done at shareholder meetings or by written resolution– business decisions cannot just be made without consultation of other shareholders.
- Directors – Directors supervise the management of the corporation’s business – they are responsible for appointing the officers of the corporation – the actual people who run the company – directors are always individuals.
- Officers – Officers hold positions in the company, i.e., President, CEO, CFO, Secretary and Treasurer – their duties are set out in the by-laws of the corporation – they manage and carry out the day to day business of the corporation.
3. Business Losses
You are unable to claim any personal losses in an incorporated company. Remember, the corporation is a separate entity unto itself. You are an “employee” of the corporation. If the corporation fails, you are only able to write off the amount of money you personally invested in it, not the accumulated negative earnings.
All of this sounds undaunting and onerous but really is not. I recommend incorporation because of the protection of legal liability. While it is more expensive at the outset, the benefits far outweigh the drawbacks.