To Incorporate or Not To Incorporate: that is the question, and it’s one almost every owner will ask themselves at some point in their business journey.
Incorporation means making your business a distinct and legal entity that is separate from you (unlike sole proprietorship and partnership, which are how many businesses start out). You should consider incorporating your small business when growth, liability concerns and shareholders are on the table.
If and when to incorporate is a decision with potentially big impacts – both positive and negative. Like most major decisions for your company, this is a complex one. Before you make it, you need to understand the pros and cons, so let’s jump in to both.
The Main Pros of Incorporating Your Business
There are many reasons to incorporate your business. First, incorporating allows you to have shareholders, making it easier to raise capital. Raising capital is also often easier for corporations because lenders may offer lower rates for loans, and because corporations can more easily attract investors. For this reason, incorporation is often an attractive choice for startups.
Many small business owners incorporate so they can take advantage of retained earnings, which is the net income left over after paying out dividends to shareholders. When they are in a growth phase, this money can easily be channelled back into the company. By keeping retained earnings in the company, instead of having to register all profit as income as a sole proprietor, you are able to access tax advantages both for your company, as well as for your personal income.
And one of the biggest advantages of incorporating is liability protection. If you are operating as a sole proprietorship and you are sued, you personally are sued. You assume all liability for the company, and your own personal assets can be seized. But when your business is incorporated, liability applies only to what you have invested in the company, adding an often very welcome amount of security to the owner.
The Main Cons of Incorporating Your Business
For most startups, there are two main cons of incorporation. First, there are some situations in which incorporating means you could end up paying more taxes (this would only be the case if your company is making more than $500k in net income OR if you have non-active business income, such as investments, etc). You’ll have less tax flexibility and will no longer get personal tax credits, unless you make yourself a salaried employee of your corporation. That’s why it’s a good idea to speak to a financial advisor before making this decision, to ensure you’re not hit with an unexpected bill come tax time.
And if paperwork gives you headaches, then you should expect a lot more headaches should you choose to incorporate. Managing pay, filing corporate taxes, keeping your records up to date and even just setting up your corporation all require extra work. For that reason, incorporating generally means that you’ll need some type of additional accounting assistance going forward.
Who Should Incorporate Their Small Business?
Ultimately, if you are at the stage where you are considering incorporation, give yourself a pat on the back. It means your startup is finding success, and you’re ready to expand on that success!
You will likely want to incorporate your small business or startup if you match four criteria:
1. You would like to build assets within your business and not take your revenue as income.
2. You want to legally protect yourself against liability.
3. You want to grow and have shareholders.
4. You’re earning more than you need to live on and would like to be able to control your income for greater tax advantage.
This is not a decision to take lightly, which is why it’s a good idea to consult with a business financial advisor before making it. A financial advisor (even a virtual one!) can also help deal with the added headaches (ie, paperwork) that incorporating will bring. When you know you can handle extra work that comes with incorporating, then you can focus on weighing the pros and cons properly for your business and your goals.