To Incorporate or Not Incorporate … That is the Question
By: Kellie Beasley
Partner, HGR Graham Partners LLP
The decision to incorporate is one that most entrepreneurs will consider at some point during the life of their business. As with most decisions there are many factors to consider. To help with that decision we encourage our clients to consider all of the factors and to consult with all of their advisors. This article is intended to outline some of the main legal factors that should be considered when making this important decision.
Liability protection is one of the main legal benefits of incorporation, especially if the business to be conducted by the company is one that may be considered “high risk”. When a company is incorporated it creates a new “person” in the eyes of the law and in the eyes of Canada Revenue Agency (more on this below). This “person” is separate from the shareholders (the owners of the shares of the company) and from the people who run the company and operate its business (i.e. the directors, officers and employees). The result of this being limited liability for the shareholders meaning that the shareholders are not liable for the company’s liabilities. The shareholders’ risk is generally limited to (1) the loss of any monies advanced to the company by way of a loan or (2) the loss of monies injected into the company as equity and any accretions to those funds. Sole proprietors or partners do not generally enjoy such protection. It must be noted, however, that directors do not enjoy the same limited liability as shareholders.
One of the drawbacks associated with creating a new corporate person is the additional cost. Incorporation creates a new taxpayer and as a result, the corporation must prepare annual financial statements and file tax returns, separate and apart from the tax returns required to be filed by its shareholders, resulting in additional cost. In certain circumstances the corporation’s financial statements must be audited which can be another significant cost to the corporation. In addition to this, the corporation will require a separate bank account (and bank charges) and to prepare annual resolutions and corporate filings (and incur the associated fees).
Companies enjoy “perpetual existence” meaning that the existence of the company will survive the death of its shareholders, directors and officers. One of the major benefits of this feature is the ease with which a company can be passed from one generation to the next or from one “owner” to another. This becomes particularly attractive when dealing with family businesses. These business transitions are much easier when dealing with a company as opposed to a sole proprietor or partnership. There are also more options available within the corporate structure when dealing with employees such as profit-sharing and employee buy-ins.
The drawback with the flexibility of a corporate structure is the need to document the rights, privileges, conditions and restrictions associated with that structure. This may involve sophisticated Articles of Incorporation, a shareholders agreement and/or reorganization documentation.
Doing business through a corporation is a widely-recognized form of doing business in Ontario. Some even say that there is a certain prestige associated with an incorporated business.
There are other tax-related advantages and disadvantages that are beyond the scope of this article. But needless to say such matters should definitely be considered when making the decision to incorporate and so an accountant should be consulted prior to taking this step.
The decision to take a business to the next level through incorporation is a nuanced one and should not be taken lightly. Consultation with trusted advisors should make this decision an easier one for entrepreneurs.