Every business model has its advantages and disadvantages. Some are capital intensive, while some need only a small amount of capital to grow. Some businesses generate cash regularly, while some operate primarily on credit. Every business starts with an idea and requires detailed attention, time, and hard work to succeed. As the business grows, so does the complexity of its operation. The trick is knowing when it may be time to move from a sole proprietorship or partnership to a corporation. When does it make sense to incorporate your business to ensure smooth operation, longevity, and credibility?
What does it mean to incorporate your business?
Incorporation is the process of separating you from your business and giving the company its own identity. It becomes a separate legal entity that the government recognizes when you incorporate your business. As the owner of a sole proprietorship, for example, you are personally responsible for your business’s debt, taxes, and credit. Incorporation separates the company’s debt and credit from your personal debt and credit.
But incorporation costs money and adds new responsibilities in terms of financial reporting and other matters. Jumping in too soon may not be the best idea. Below, we discuss some signs it may be time to incorporate your business.
When Personal Liability Becomes a Concern
It would help if you considered incorporating your business when you feel that the liability of your business is increasing beyond what you’re willing to take on personally. Before incorporation, only you are responsible for the liability of your business. And in the case of a default, you could sell your personal assets like a car and house to clear your business’s debt. However, if you incorporate your business, your liability towards the company becomes limited to the amount of your investment.
Example: Kevin runs a car rental service. He has invested $100,000 in the business. As his business grows, he buys more cars on credit, which increases his liability to around $500,000. If he incorporates the company, his liability will be limited to $100,000 if the business incurs losses or goes bankrupt and cannot repay the loan.
When You Want to Raise Capital
The best time to incorporate your business is when you want to raise capital. Incorporation makes it easier for any company to secure funds from investors and venture capitalists. Further, your business can obtain loans from banks with more favourable interest rates after incorporation.
Example: Mary provides salon services at home and wants to expand her services to a new area. She needs more capital for expansion. She needs to recruit staff, secure a space, and purchase new equipment. This is an excellent time to incorporate her business as it will make it easier for her to raise funds needed for expansion.
When You Want to Save Tax
In Canada, corporate tax rates are lower than personal tax rates. Therefore, incorporating your business can save you a significant amount of tax. Since Canada has a progressive taxation system, your tax burden increases as your income rises.
Example: Lara operates a marketing business that earns $100,000 annually. If she runs the business without incorporating, she will have to pay almost $18,000 tax on the entire income. However, if she incorporates the business, she will have to pay only 9% tax on $100,000, which comes to $9,000.
When You Want Your Business to Outlive You
Once you incorporate your business, it becomes a separate entity from you. Under Canadian law, your business will have the same obligations and rights as any other person after incorporation. It can sign agreements and deals, secure loans, and buy property and assets. Your business will continue to exist even after you die. Incorporation makes it easier to transition the company to your spouse, children, or another third party to continue in your absence.
Example: Harry operates a software firm. He is 55 years old and is thinking of retiring now. His children are interested in taking over the business one day but are still in school. If Harry retires without incorporating his business, it will likely mean shutting down entirely or transferring all business rights to an outsider since his kids aren’t ready. However, if he incorporates the business, he can hold a certain amount of shares in the company, giving him control in the interim. Harry can transfer these shares to his children once they are ready to come on board.
The Dangers of Not Incorporating in Time
- If you do not incorporate your business and it runs into losses, you will be liable to clear the arrears even if it requires selling your personal assets.
- You will pay taxes at personal rates instead of corporate rates if you do not incorporate your business. In Canada, personal tax rates are higher than corporate tax rates.
- If you do not incorporate your business, it may cease to exist after your death or retirement, as your business does not have its own identity.
Contact McCay Duff LLP in Ottawa for Strategic Incorporation Advice for Business Owners
Only you understand the needs of your business. Only you can decide when is the right time to incorporate your business, depending on its financial situation and stability. But we can help.
At McCay Duff LLP, we advise businesses on strategy and financial planning. We work directly with business owners to implement growth strategies and achieve the most favourable results for small business owners and their families. If you would like to discuss making a business plan that will better benefit your organization, contact us to schedule a consultation. Please reach out to us online or by phone at 613-236-2367.