At some point in time, every business owner considers whether or not his or her business should be incorporated. The structure of a business is fluid and may change with time. Often small businesses initially take the form of a sole proprietorship or partnership but, as they evolve, a corporate structure is adopted to grow and develop the business. When deciding whether or not to incorporate a business, the owner should consider the benefits and drawbacks of incorporating and running the business through a corporation.
What Are the Benefits?
There can be many benefits to incorporating a business. For instance, given that a corporation is considered a legal entity separate from its owners, the owners’ liability is generally limited to the value of the assets that they convey to the corporation (such as money, property, or past services) in exchange for receiving shares in the corporation. In contrast, sole proprietors are responsible for the liabilities of their businesses to the full extent of their personal assets. In addition, incorporating a company may be preferable where there will be a large number of owners.
Corporations are often also entitled to preferential rates of taxation compared to a sole proprietorship or a partnership. In addition, certain financial institutions prefer to loan funds to corporations. Consequently, a corporation may offer greater flexibility in obtaining financing.
Another advantage is that while a sole proprietorship and a partnership (unless otherwise specifically stated in a partnership agreement) will cease to exist on the death of an owner, a corporation will continue to exist despite the death of or sale of shares by an owner.
Moreover, a share structure can be designed such that the owner’s family members receive financial benefits while the owner maintains control of the business. When preparing a will, it may also be most convenient for an owner of the business to pass on an interest in his or her business through shares in a corporation.
What Are the Drawbacks?
When considering whether to incorporate a business, one must also consider the disadvantages. For example, the cost associated with incorporating and maintaining a corporation often exceeds the cost associated with other forms of business organizations such as sole proprietorships and partnerships. In addition, a corporation will often incur higher recurring legal and accounting costs. A corporation is also obligated to prepare and maintain its articles, by-laws, and their amendments; minutes of meetings and resolutions of the shareholders and the directors; as well as registers of directors, officers, shareholders, and debt obligations. A corporation must also prepare and maintain adequate accounting records and, in the case of federal corporations, file annual returns. One should keep in mind, however, that preparing or amending a partnership agreement may cost as much in legal fees as the incorporation of a corporation or the execution of corporate amendments.
Moreover, a corporation’s income is calculated and subject to tax at the corporation level, separate from that of the owners. An owner cannot treat the net income or loss of the corporation as his or her personal income or loss. If the business incurs net losses, the owner cannot deduct these losses from his or her personal tax return.
Directors and officers of a corporation are bound by certain legal duties. They have a fiduciary duty to act honestly, in good faith, and with a view to the best interests of the corporation. Directors and officers also have a duty to exercise the care, diligence, and skill of a reasonably prudent person in comparable circumstances. If the owner is also a director or officer of the corporation, the owner may be liable for the actions or omissions of the corporation and for his or her own actions and omissions.
Finally, both Ontario’s Business Corporations Act and the Canada Business Corporations Act contain certain citizenship requirements in respect of directors of corporations. This may pose some difficulties for a business owned by foreign shareholders.
In most circumstances, the benefits of incorporating a business outweigh the drawbacks. This is probably the reason why a corporation is considered to be the most common form of business organization.