The question of whether or not to incorporate is one faced by both new and already established businesses. Despite being a commonly asked question, it is not one with a simple answer. It is the question of whether or not to incorporate that was the subject of one of my discussions with Paul Westlake and that is the subject of this installment of my blog series.
When deciding whether or not to incorporate, a sole proprietorship or partnership must reflect on the status of their business and what they hope to achieve out of their business.
There are both advantages and disadvantages associated with incorporation. One advantage is that it limits personal liability. I stress that it only limits personal liability, as opposed to removing it all together.
A corporation is a separate legal entity with rights, powers and privileges of a natural person. This means that it can sign contracts, bring claims and be sued like you or me. A properly drafted contract with a corporation is with the corporation itself, not with the officer or director who binds the corporation (corporations act through natural people who are appointed as officers and directors).
There are situations, however, where an individual will be at risk personally despite the fact that the business has been incorporated. For example, if a start-up business approaches a bank for a loan, the bank may require a personal guarantee since the business will have no financial track record. The bank will want this personal guarantee to protect itself.
A sole proprietorship, in comparison, will be personally liable in the aforementioned situation without the need for the bank to ask for a personal guarantee. If a sole proprietor is in breach of a contract, a claim can be brought against him or her personally. If the sole proprietor is unsuccessful in defending him or herself, he or she is personally liable for the judgment against him or her. Therefore, using the example of a sole proprietorship which has obtained a loan from a bank, the bank would have the right to pursue the sole proprietor if he or she were to default on the terms of the loan.
Another advantage of incorporation includes a potential reduction of income tax payable. To achieve this, you should seek professional advice from a tax accountant or tax lawyer.
As I mentioned earlier, there are disadvantages to incorporating as well. One such disadvantage is cost. For example, there are costs associated with the incorporation process, such as the cost of conducting a name search, governmental filing fees and legal fees (if you retain a lawyer to assist you).
Secondly, once incorporated, the corporation must be sure to file an annual tax return, and comply with the relevant legislation (in Ontario, the Business Corporations Act). The minute book must be kept up-to-date and various filings must be completed.
Further, it is more complicated (and generally more costly) to dissolve an incorporated business.
When deciding whether to incorporate, you should consider the nature of your business and how these advantages and disadvantages apply to you. For example, you should ask yourself whether you will be working in a high risk business. If so, increased protection from being found personally liable in actions against your business may be a sufficient incentive to incorporate from the beginning.
Another question you may ask yourself is whether you are committed to making your business grow and confident in your ability to do so, or merely testing the waters. If you are testing the waters (not confident that you have a viable business), you may consider holding off on incorporation until some time has passed and you have determined you have a viable business capable of longevity. (Just because you decide not to incorporate now does not mean you cannot incorporate at a later date.)
Overall, as is the case with most legal questions, the quick answer to the question of whether or not to incorporate is “it depends”. The answer will vary depending on your own situation. That being said, it is an important question to ask and one that is deserving of thought and discussion.
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