More often than not, small businesses begin their lives with one person, an idea and the simplest of all company structures: a sole proprietorship.
But entrepreneurs with big dreams shouldn’t wait too long before they examine the benefits of incorporating their business — even though it comes at a price.
“For those who want to grow and hire people, a corporation is by far the preferable structure,” says Steven Karpenko, a director at BDC.
Self-employed workers often start out operating as sole proprietorships, in which the entrepreneur directly owns all of the assets and is personally responsible for all the debts and liabilities. One key advantage of the sole proprietorship structure is its simplicity, especially when it comes to paperwork. For example, the company’s tax information is reported on the owner’s personal return.
Easier ownership transfers, limited liability and unlimited life
However, most businesses convert into corporations as they grow because this structure offers several advantages over sole proprietorships:
- Ownership stakes are easier to transfer.
- Owners benefit from limited liability.
- The life of the corporation can extend beyond that of the founder or founders.
A corporation is a separate legal entity and owners do not own its assets directly. Instead, they own shares in the corporation, which in turn owns the assets. This makes transferring ownership stakes much easier. “Venture capital firms and angel investors, for example, like to know they can get in and out of an investment on pre-agreed terms without delays caused by a muddled organizational structure,” Mr. Karpenko said.
Limited liability means the owners are not personally responsible for the obligations or acts of the corporation within legal limits. Potential losses are limited to the amount invested in the corporation, except if the owner has provided a personal guarantee, which many banks require.
The other key advantage that incorporated businesses have is that they benefit from a theoretically unlimited life. When shareholders die, their shares are willed to their heirs or transferred through a sale. Sole proprietorships, on the other hand, automatically dissolve when their principals pass away.
An instant dose of credibility
“Incorporating a business, as opposed to other forms of organization, provides an instant dose of credibility for a business owner,” Mr. Karpenko added. “Potential investors, lenders, suppliers, customers and employees all get an immediate signal that you are serious and thinking about the longer term.”
That said, incorporating a business does require some additional cost and effort. For one, a corporation needs to maintain a separate set of accounting records, distinct from those of its owners. Corporations must also pay annual registration fees, and must file separate financial statements and tax returns.
According to Mr. Karpenko, however, these inconveniences are well worth the effort.
“It’s hard to find businesses of any significant size that are not incorporated.”
Content in this section is provided in partnership with the Business Development Bank of Canada. BDC provides entrepreneurs with financing, venture capital and consulting services. To find out more go to BDC.ca.
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