As you’re working out the details of your business plan, design early prototype, or even pre-sell your product, you may be wondering: when is the best time to incorporate my venture?
If you ever find yourself in this situation, you’re not alone. I personally wondered about the same thing 7 years ago when I launched my first startup.
As I look back, analyzing every company that I’ve personally launched, and all the startups that I’ve helped incorporate, there is always this distinctive moment, situation, or an opportunity, that usually prompted me to convert an idea or a personal hobby into a legal entity.
In this article, I’m sharing some benefits you might want to consider when contemplating having your startup to be incorporated, as well as giving you 5 realistic scenarios that call for an idea to be turned into a company.
What are the benefits of incorporating your business?
When starting out, it’s very common and quite OK to develop a product or service, market it to clients, and even accept payments without any corporate structure in place.
It works well if you do an odd job like helping a friend with taxes once a year, or creating a website for a colleague who wants to start an e-commerce business.
But as more customers find out about you, and start buying your product, more reasons there are to finally pull the trigger and separate your personal and professional activities. Below are some of the benefits to consider when considering incorporating your business.
1. Registering a business limits your personal risk.
Say you provide web development services. You build custom templates for e-commerce startups that want to differentiate themselves and their products on the web.
One day a client calls to complain that their website got hacked, and all their client information got exposed: names, payment details, order history. Not great.
If the website was poorly developed, it’s technically your fault. Nothing prevents an e-commerce client from pursuing legal action on behalf of their clients who got hacked. Since no company has been registered, you will be personally liable for any damages, and may end up paying severe penalties out of your own savings.
That’s why one of the reasons companies get started is to limit any personal liability. When a business gets incorporated - it creates a “bubble” around the product or service, and all the interactions clients, investors, teammates, and the government have with that business are separated from the entrepreneur who runs it.
After incorporating your business, you can have a piece of mind knowing that nothing that happens in the business will have a negative effect on your personal finances. Your hard-earned savings - secured! 😉
2. Incorporating a business allows you to save on taxes
Back to the website development services example. Your business is doing terrific, clients are lining up outside your door, and are paying big dollars to buy website services from you.
Closer to the end of the year you realize that your “business” brought in over $100,000 in revenue. It is your happy moment to reflect on all the hard work you’ve put in in the past 12 months.
There is only one catch: CRA is just as happy - to collect the tax on your earnings.
Depending on your financial situation, you might have to fork off close to 50% of your earnings back to the CRA. Not such a happy moment anymore.
When you incorporate your business, however, it changes your tax situation.
Firstly, many small businesses starting out have a more lenient tax obligation. In Ontario, for example, your newly formed company can enjoy a tax rate of 13.5% on any income below $500,000 / year.
Secondly, your business is eligible to deduct more expenses from revenues than an individual could. Got a new computer for yourself? Write it off. Hired a marketing agency to help out with your social media posts? Deduct that as well. All of a sudden, your business can show lower income and only pay taxes on what you actually earn!
When is the right time to incorporate a business?
Now that you’ve decided that the benefits of having a company registration outweigh the effort to do so, the question is when is the best time to do it.
In my 7 years of starting and building businesses, I’ve always given myself a bit of time to develop my business before making it official.
With that said, sooner or later you should incorporate - to avoid the awkwardness of having to cash a client cheque, only to realize that you need a business registration to open a bank account first.
Below I’m sharing 5 events that prompted me in past to formalize my business:
1. Incorporate when your idea is fully formed
So you got the idea, and you’re excited to share it with the world.
At this point, it might be beneficial to validate your idea before forming a company around it. Ask questions, get expert advice from other entrepreneurs, conduct client interviews.
It’s also a good idea to run basic financial projections, and ask yourself a question: “Can this idea become a business from a financial standpoint?”
And when you feel comfortable committing to this idea, go ahead and reserve that professionally-sounding “ACME Technologies Inc.” name for your business.
2. Incorporate when you apply to an incubator or an accelerator
Every major city in Canada now has one or several organizations that support entrepreneurs. These organizations are called “innovation hubs”, “incubators”, and “accelerators”, and their mission is to support entrepreneurs to evolve their idea into a product, and eventually create a sustainable business around it.
One of the prerequisites of joining an incubator is having an incorporated business. This is done to avoid any liability on their end, but also to be able to report their progress to the government, introduce you to potential investors, and even recommend your services to some of their partners.
The support that these organizations provide, which is usually free, is well worth it, and so it’s a good time to incorporate your idea into a legal entity, when you get accepted into one of these groups.
3. Incorporate when you decide to apply for grants or raise capital
One of the ways to bootstrap your business venture is to attract external funding. Notably, government programs exist to support local entrepreneurs to build businesses and create jobs. This support comes in the form of grants - a payment from the government, that is usually non-repayable. For an entrepreneur to apply for a grant - no matter how early in their ideation phase - he or she is required to incorporate a business and assign directors - executives in charge of all the decisions in business.
Similarly, many wealthy individuals and professional investors seek to put their money behind entrepreneurial ideas that show promise. This is sometimes called “angel investing” or “venture capital investing” depending on where the money comes from. For investors to invest, they also require a business to be incorporated
4. Incorporate when bringing a co-founder or hiring your first employee
Most entrepreneurs start out working out the kinks of their future business by themselves. It makes sense to take time to research the problem and come up with the business model, before involving other people that might help to build and sell the product.
But when that time comes - whether to bring on a co-founder or to hire a first employee - it’s highly recommended to do it within an incorporated entity, rather than personally. It comes back to issues of liability and tax that I mentioned before:
- Bringing on a co-founder who may also become a part-owner of your company requires issuing shares. And the only way to issue those shares is to have a company in place.
- Hiring employees means taking on a commitment to pay their salary. Tying that commitment to company finances, rather than your personal finances, is recommended.
- Paying co-founders and employees a salary - once you can afford that - is a tax-deductible expense, and would dramatically reduce the amount of taxes paid, if your business is incorporated.
For these reasons, if you reach your personal capacity as a solo entrepreneur, and would like to bring more people to help you with your business, it might be a good time to actually incorporate your venture.
5. Incorporate when you make your first sale
Nothing beats the thrill of making that first sale. From getting people to find out about your product, to have them hooked, to actually making a sale may seem like forever sometimes. So it doesn’t surprise me that many entrepreneurs celebrate this occasion as intensely as if it was their own birthday.
It’s also a great opportunity to think about rolling your product into a corporate entity.
A sale is a validation like none other. But you don’t want to be in an awkward situation, where after invoicing the client and getting a cheque - you’re not able to deposit it without having a corporate bank account.
Most clients, particularly other companies prefer to pay companies rather than individuals, for goods and services they buy. Not only do buyers take incorporated businesses more seriously - but they also have a higher chance to enforce the delivery of goods if an entrepreneur was to take off with the money.
While it’s definitely OK to sell to your friends and family without a corporate registration, or ask to transfer money to your personal bank account, getting external customers to buy from you might require an incorporated business in place.