Is it better to incorporate or stay as a sole proprietor?
Goodness – this is a question we hear every day. So, should you consider incorporating your business? Regardless of whether you’re just starting a business or transitioning from sole proprietor to a corporation, the road to incorporating is a very important process, with advantages and disadvantages along the way. Knowing these ahead of time will help set your business up for success from the start!
Of course, there are advantages to incorporating, otherwise, no one would bother with the paperwork. The ones that lead the conversation towards incorporating are often limited liability, independent lifecycle, ability to raise or receive financing, and the specific tax advantages.
Perception of Limited Liability
An incorporated business offers the perception of limited liability to a company’s shareholders, meaning you – the owner – have less liability than if you were a sole proprietor. Should your company be liable, your personal assets will have greater protection.
Supporting this perception of limited liability is that “limited liability” makes it easier to sell your business. Why? If you are a sole proprietor, the division between what is business and what is personal is too gray. Within a company, this division is more defined. You have a clearer understanding of what the business assets and liabilities are versus what your personal assets are. This division makes it more appealing to potential buyers.
Not only that but, whether right or wrong, some customers may perceive you as being bigger or more sophisticated than a sole proprietorship. Determine what immediate perception of your company you would like your business to have.
A corporation has a life of its own, separate from you and any shareholders. If you, or another shareholder, leaves the company, so long as there are remaining shareholders, the company will carry on. Whereas, if you are a solopreneur and you leave your company, the company closes down with you.
Raising Money or Receiving Financing
Businesses are always going to need financing in some form or fashion. When you incorporate, you create a more viable picture of what investors will be investing in. There is easier access to the company because the company isn’t “you.” This clear definition between business and person creates comfort for investors, whether angel or venture, in understanding what the business – not the individual – is worth.
When you incorporate your business, you have the ability to optimize your income and the related taxes. Since the company is a separate entity, you can choose to take – or not take – an income from the company. You then manage what income comes to you and how. This is a big advantage as it allows you to decide if your income will be a salary or a dividend. Both have their own advantages and disadvantages regarding their impacts on income tax.
The conversations here should focus on tax benefits, tax deferrals, and how to best optimize the type of income you take. This is very situational to the specific business and business owner. The main question to consider is, whatever your company is making, do you require that income to live personally? Your answer will guide the conversation as to whether or not incorporation makes sense for you and your business.
For every yin, there is a yang and incorporating your business is no different. Just as there are advantages to incorporating, there are equally important disadvantages you must consider.
Potential to Double Financial Costs
Just as you always do, you have to file your personal tax returns. Now, as an incorporated company, you will also have to file various corporate returns, which often sees an increase in your accounting and bookkeeping costs throughout the year.
Increase in Paperwork
Exactly what every business owner wants more of – paperwork! When you incorporate, by law you must maintain a corporate minute book, ensuring it’s up to date with shareholder meetings, resolutions, and items of the like. Additionally, you will have to register your business on an annual basis, meaning more paperwork (even if only in the electronic form).
Misperception of Liability
Yes, there is the perception of limited liability, which is still true. However, your liability may not be as limited as you think.
For example, if you go to the bank for financing for your company, the bank usually asks the shareholder (AKA: you) to provide a PERSONAL GUARANTEE for the loan in the event the company cannot repay the loan. This erodes the “limited” in “limited liability” and still leaves you accountable for financial repayment.
Corporations are Expensive
Corporations aren’t cheap and while you can set one up yourself, we recommend that you sit with a lawyer to begin with to understand all the ins and outs of what it means to be a corporation. This will help you understand what exactly a “company” is and what liability you are responsible for as the owner of the corporation, along with the other regulations you must follow in accordance with the law.
Over and above additional professional services, you must ensure your annual registration fees are paid to keep your company in good standing. In Alberta, this renewal costs approximately $100 / year.
Extra Hurdles to Close the Business
When you decide to close a corporation, it’s a bit more in-depth than hanging a sign on your old office door saying “Closed. Thank you for your patronage.” Namely, you must close down all the various government accounts you have and submit a final corporate tax return. From there, you must also distribute any assets and/or liabilities to the shareholders.
The benefit here is that if you start a business with the intent of selling it, knowing this ahead of time will help you minimize some of the unknowns and put you in a better position to sell and then easily close the remaining aspects of your company.
Incorporating is great, but since there are more requirements of you as the owner, it’s worth taking the time to assess 1) if incorporating makes sense for you, 2) when incorporating makes sense, and 3) what you need to prepare in order to incorporate as easily as possible.
Really, there’s no right answer as to whether you should or should not incorporate. It truly is a conversation as it can’t be a simple checklist that decides whether you’re ready. Eager to start this conversation about your own company? Contact Priority Business Solutions and start asking your questions!