In short, Yes!
Clients criticize me sometimes for not being more directive. For laying out the pros and cons and then telling them to decide. So this time I will invoke what one of my old bosses used to call the “right answer theorem”. And the right answer is yes, you should incorporate your small business.
I should clarify… my audience is small and medium-sized business owners, not micro-businesses. As I write, I’m assuming that you have already made the plunge into entrepreneurship and you have:
- a bunch of customers;
- revenues of at least $1MM;
- some employees; and
- some assets, both the company and personally.
With that in mind, if you’re asking the question, “Should I Incorporate My Business”, then you probably should. A quick search on the web of this question will no doubt find you a balanced Pro vs Con analysis of this question, with the pros normally beating the cons by a hair, Honestly, what utter bullshit! The Pros absolutely murder the Cons in most cases.
I’m not going to fill this post with material about the characteristics of the various forms of company organization – sole proprietorships, partnerships, co-operatives, and corporations – but will rather assume the reader knows the basics already and needs to understand which one fits their situation best. I’m also going to skip the co-op since the business’ purpose often is what leads to the choice of that form.
So which form makes the most sense in your case?
Sole Proprietor
Absolutely the simplest and easiest way to start a company, the sole proprietorship really only applies for the smallest of businesses, with relatively modest needs for capital, assets, and employees. Many businesses start here and then quickly move on to incorporation, however, a freelancer or micro-business owner may continue to use this form indefinitely. But really, only them. The kicker here is the unlimited liability that comes with this form of ownership. The fact that there’s no legal separation between the company and the owner means that they are on the hook personally for anything that happens in that company. Saving a few bucks on incorporation costs (or even taxes!) just isn’t worth this risk.
General Partnership
Almost as simple as the sole proprietorship, partnerships are formed upon the agreement of one or more partners. Normally this should be enshrined in a partnership agreement but it need not be. The partnership’s name will have to be registered with the government (unless you only use the names of the partners, e.g., Brad Poulos and Steve Stevens) but otherwise, it takes no red tape to set up. Like the sole proprietor, the General Partners (GP) in a partnership are personally liable for the debts of the partnership. Both jointly and severally. So when one partner messes up it’s possible the other partner or partners, especially if they have deeper pockets, will be on the hook. That alone should steer you toward the corporation.
Limited Partnership
A Limited Partnership differs from the General Partnership in that a Limited Partnership can have both General Partners (at least one) who is responsible for running the business day-to-day, and is liable for any debt of the business, as well as Limited Partners (LP) who are not involved in the operation, and as a result whose liability is limited to their investment.
Limited Liability Partnership
Certain professions can take advantage of a Limited Liability Partnership (LLP). The rules around LLPs vary greatly throughout Canada and the US. In Ontario, LLPs are permitted provided that the profession is governed by an Act that allows an LLP to practice as a profession (for example, in the case of midwives, it is the Midwifery Act, 1991, for accountants it is the Public Accounting Act, 2004). If you fall into this category, an LLP makes very good sense.
Corporation
Why not incorporate your Small Business???
I’m going to go in reverse order here and lay out the normal arguments against corporations, debunk them, and then make the case for the corp as the go-to, default, automatic, choice. Of course, there are exceptions.
Costs
This one is a real laugher. The costs are:
- the cost of incorporation itself which is $200 for a DIY online incorporation in Ontario, or around $500 if you have a professional like David Michaels do it for you;
- “costs” associated with filling out and filing forms, which as far as I know is one form per year with a filing fee of $12 that takes 5 minutes to complete online;
- lawyer’s or paralegal fees for a shareholders’ agreement, which implies more than one owner, so in that case, you’d still want a partnership agreement and the cost is the same as a shareholders’ agreement;
- the cost of filing taxes, which might be slightly higher than with the sole proprietor and is likely the same as filing taxes under a partnership.
Not a very compelling argument for putting everything you own at risk.
Taxes
At low revenue and profit levels, it’s possible that you’d pay less tax if you didn’t incorporate, but as revenues and profits rise, the flexibility in tax strategies offered by a corporation will be much greater. If you plan to stay small and have limited profits, why do you read this blog??
Increased Complexity and Paperwork
Also a bit of a laugh. Most of the paperwork demanded by the federal, regional, provincial/state and municipal governments is a result of the business, not because it’s a corporation. Payroll filings, sales tax payments and filings, and other compliance documents are required regardless of the form of organization.
Eliminates Ability To Represent Oneself in Federal Court
This is from a paralegal friend of mine:
One downside of being incorporated instead of being a sole proprietor is that you cannot represent yourself in Federal Court without permission from a judge. Your business could suffer a default judgment if it can’t afford the legal fees that even baseless claims can cost.
Should I Incorporate My Business?
Now the compelling arguments in favor of incorporating.
Limited Liability
This is where it begins and ends with me. Hands down, the big advantage to incorporating is the limited liability offered to the owners of the incorporated company. The corporation is a separate legal entity from the owners, unlike the sole proprietorship or partnership, so a debt of the company is not necessarily a debt of the owner. The term “limited” liability means that an individual shareholder’s liability is no greater than the amount they have invested in the company. You can still lose everything you invest, but unless you’ve signed something to the contrary, no one can come after your house, car, boat, or firstborn child.
Raising Capital
It’s illegal to sell even a part of yourself, so raising capital in a sole proprietorship is very difficult. Nigh on impossible unless you are using the capital to purchase physical assets. A corporation can borrow money, or issues shares, in order to obtain additional capital for expansion in its own right.
Income Splitting and Tax Deferral
Another huge advantage of the corp is the ability to split income with family members and plan for future events like retirement or the death of the founder. Corporations pay a different tax rate than individuals, and dividends have different tax treatment than salary or bonuses. Plus a spouse paid a salary by the company has a lower marginal tax rate than their spouse who is taking a larger salary from the company. Your tax accountant can use these facts to determine the best mix of company profit, bonuses, and dividends paid to the various family members and can minimize the overall tax burden at the family level, leaving greater wealth for future generations.
Continuity and Estate Planning
When the sole proprietor of a business dies, the business dies with them. The assets of the business would be distributed based on the owner’s will, and while it is possible for the business to continue, it can be tricky to reconstruct it under a different individual or a corporation. If that same owner had simply set up a corporation, the business would not die with them. It would still have assets, a bank account, employees, customers, and loans. I would just have a new owner based on the instructions in the deceased owner’s will. The business would carry on as before, with the obvious disruption that would come from the loss of a key person, and most likely its top leader.
Credibility
Having the Limited, Ltd., Inc., Corp, Corporation, or other designation following your company name implies a certain level of sophistication that lends credibility.
So the answer to the question, “Should I incorporate my business?” is probably yes.
This brings up the question of whether you should incorporate federally or provincially. I usually default to Federal. If you are planning on operating or doing business in more than one province, I would go with Federal. You still need to register in each province if you’re going to do business there, but you will have guaranteed use of your business name by virtual of the federal registration.
If you’re in doubt contact your lawyer, paralegal, other trusted advisor or me.