Whether you’re a business owner operating an existing revenue-generating business, or a startup founder looking to formalize a unique idea- it’s quite common to ask whether you should incorporate.
As an entrepreneur myself, I’ve started and built several businesses, as well as worked with some early-stage businesses as an advisor - and every time we would incorporate our company, after we reached a certain milestone: first institutional client, angel investor interested in supporting our venture, or a strategic partnership opportunity.
But incorporation is not for everyone. Below, I’m sharing my personal experience on the pros and cons of incorporating a business, starting with the definition of a corporation.
What is a Corporation?
A corporation is a company that gets created during the process of incorporation. In essence, it’s a (legal) entity that is created to manage revenues, expenses, assets, and liabilities. A company exists separately from its owners - in a sense that shareholders are not personally liable for any risk that a company may incur - such as financial loss or a legal lawsuit, for example.
Below we’ll discuss 5 advantages of turning your business into a corporation.
5 Reasons to Incorporate Your Startup Or A Small Business
1. Taxes Reduction
Unlike a sole proprietorship, or a side-hustle you may run without registering, an incorporated business has access to lower tax rates on income, higher tax deductions - compared to personal income - and other tax benefits available to small businesses.
Firstly, incorporated entities pay less tax on the income they earn, compared with individuals or sole proprietors. For example, a corporation in Ontario would enjoy an overall tax rate of only 13.5% on income after expenses below $500,000/year. That same amount would be taxed at close to 50% for individuals earning income, or sole proprietors running a similar business without corporate registration.
Secondly, incorporated businesses can deduct expenses - such as phone bills, marketing costs, business attire, transportation costs, office costs (including home office), supplies, and much more - in order to reduce taxable income - or the net amount that is left after expenses to be taxed as profit.
Thirdly, corporations are in a great position to apply for small business financing and tax credits. Many provinces in Canada have grants, loans, and tax incentives available to incorporated entities - that would not be available to individuals running an unincorporated side hustle, for example.
2. Limited Liability
Running a business is risky. And not just because it requires a lot of investment and personal sacrifice.
Businesses carry all sorts of financial and legal risks. Companies default, declare bankruptcy, get sued by their competitors and legislators.
Without incorporating, a business owner takes on the full risk, and is personally liable to repay any damages or to absorb losses. That means that even personal assets - such as home and money put aside for kids’ tuition - can get tied up in the lawsuit against the company.
That is why incorporation exists: to shield any individual against a liability related to business operations.
One of the advantages for the business owner to incorporate their business is that it creates a protective bubble that prevents any company-related activities to impact individuals who are involved with the company. Any losses, liabilities, and risks are kept separately from shareholders and directors who are involved in the business day-to-day.
For example, if the company defaults, it will not affect the personal credit history of company executives and employees. Be careful, though, as any illegal activity can still be traced back to the individuals involved.
3. Transfer of Ownership
Another advantage of incorporating a business is the ability to create, allocate, and transfer ownership in the company.
Businesses that are not incorporated are usually owned by individuals who run them. These startups or side-hustles produce income that gets attributed directly to the founder.
As business becomes more mature, and needs to formalize itself in order to grow and attract external resources (such as capital), incorporating a business creates a mechanism to do so.
After incorporating a business, business owners become eligible to issue shares. Shares represent the control and ownership in the company - and can be used to raise capital, attract co-founders, and sell a business.
For example, if an incorporated business is looking to grow from $50,000 / year to $500,000 / year in revenue, it can issue shares, and transfer 15% of those shares to an investor, in exchange for a sizable investment in the company.
4. Indefinite Lifespan
Another advantage of incorporating a business is granting it an indefinite lifespan. While individual businesses start and finish with the business owner’s involvement - corporations carry on, even beyond the tenure of the original founder.
Once incorporated, the company may go on forever. For example, General Electric was founded by none other than Thomas Edison in 1890. Rothschild Co. - the most iconic old-world bank - was started by a wealthy Rothschild family in 1810 - and still exists today. World’s oldest company - Kongo Gumi - a Japanese construction company - was formed in the year 578 to build shrines and temples.
5. Financing Opportunities
Corporate structure allows businesses to sell a portion of the company, in the form of shares, to attract external capital. For that reason, incorporated businesses have a higher chance of attracting investors. Angel investors, venture capitalists, and strategic corporate funders look for businesses to allocate their capital to, but will prefer for a business to be incorporated.
The government too provides non-dilutive grant financing to small businesses. While they regularly provide individual grants to aspiring entrepreneurs, entrepreneurial youth, and business immigrants, to foster innovation - small businesses have even more government funding options, in a form of small business financing, asset purchasing loans, employment subsidies, and even investment matching programs.
Debt financing is also more abundant for incorporated businesses. Banks and credit unions, for example, are happy to extend financing to businesses that have assets or a strong revenue earning potential. When building a factory or opening a coworking space, you might be able to finance the majority of equipment purchases and leasehold improvements, using debt financing, instead of having to put up your own capital. These financial institutions require a business to be incorporated. Unincorporated businesses might still be able to apply and get these loans, but it may come at the risk of having to provide a personal guarantee.
3 Downsides To Consider Before Incorporating Your Venture
1. Higher Cost
Incorporating a business has the downside of having to pay more.
Typical incorporation in Canada costs about $200 - $300 in government fees. That includes a name search and registration, as well as filing the initial articles of incorporation. Every year, you would also pay a renewal fee, to keep the corporation ongoing.
Putting together all the required legal and administrative paperwork would also cost more, when compared with creating a sole-proprietorship. Startup Incorporation Packages are very costly when hiring a traditional law firm, where lawyers charge $250-$500/hr to fill out forms on your behalf. There are some alternative options - like coSquare - that don’t cost as much, and allow you to incorporate at a much lower rate without sacrificing quality - but you should still expect to incur higher fees in the future, when your business grows.
Besides paying a lawyer, you should also budget for other expenses, like accounting and bookkeeping. In order to extract maximum tax benefit, you would need expert advice on classifying all the expenses in your business and filing annual tax returns. As your business expands, and more transactions occur every month that require accounting help, you should be prepared to put aside at least $1,000/year to ensure accurate and timely tax returns.
2. More Legal Work
Starting a corporation requires more legal effort, compared to creating a sole proprietorship, which is quite simple.
Firstly, you need to create and submit articles of incorporation, telling the government what business you’re intending to operate, and asking them to formalize your legal entity.
Secondly, you would need to create and maintain a series of documents that outline the name and structure of your business, list the decision-makers in your business, their rights and obligations, and keep track of all shares that co-founders and investors own in the business. Every time an important decision is made that requires your co-founder’s or investor's approval, it also has to be documented and stored in a legal archive called Minute Book. As changes are made (new directors are getting hired, or investors join the board), those documents need to be revised and updated. As a business owner, you’re also required to renew your corporation by filing an annual return once a year.
You can avoid doing the paperwork yourself. When incorporating with coSquare, we take care of your incorporation process and creating the minute book - so you can focus on building your business.
3. More Complex Accounting
Ok, we are not talking about 'cooking books' here. 😂
But running a corporation requires its owners to pay close attention to numbers, and invest more into accounting and bookkeeping efforts in order to make sure the tax benefits of being a corporate entity are maximized. When sole proprietors do a limited number of deals a year, it directly translates into less accounting work on their end. And if business comes to halt - so do their accounting needs.
Corporations, however, always need to do accounting - particularly when retaining employees, incurring expenses on marketing and product development, or keeping track of all the shares issued, and how investment capital is being allocated. Corporations also get audited from time to time - meaning that you have to retain accurate financial records from previous years - even if your company stopped operating.
So is it a good idea to incorporate your business?
Your decision to incorporate should be based on how far you are with your business.
If you’re just starting out, don’t have many clients, and don’t expect to raise capital or attract co-founders to help you launch the product into the market - then you can stay unregistered, or create a sole-proprietorship to operate out of, until your business starts to take off, and it makes more sense to formalize your operations.
On the flip side, if your product is already in the market, and you’re looking to minimize personal risk while taking advantage of corporate tax and financing benefits, you should definitely consider incorporating. Even after the incorporation process, it’s still unlikely that you’ll have to start actively paying for legal and accounting work, at least until after your first year in business as an incorporated entity - so you might have enough time on your side to make it worthwhile short- and long-term.