You have this amazing idea, you know you can help people, and you’re sick of your 9-5 job – so you make the choice to start your own business. It’s scary, but SO liberating.
Great! You’ve decided! You’re doing it! Yay!
Should you incorporate? It would feel so official to incorporate. You’d have a real piece of paper saying you owned a company! You could take a selfie with it to keep as a record of this exciting new chapter in your life!
Let’s slow down. I totally understand this feeling. When I started my business, I wanted everyone to know. I was SO excited to go on an adventure and leave my old life behind.
An Incredible Journey
On your journey, you need the right tools. Think of your business form like a backpack. You want your pack to be the right size and weight for the adventure you’re on, so it doesn’t slow you down, but has everything you need in it.
If you’ve headed out for a day trip, maybe a small backpack that can hold your lunch and a couple water bottles is all you need. It would be nice and light, but would have everything you needed for the day.
What if you wanted to go on a multi-day trek up the side of a mountain? You’d want to have a big camping pack with a tent, a sleeping bag, a change of clothes, and a bunch of food and water.
Now think about having that big camping pack on your day trip. It would take far more energy to haul that pack around than the small backpack with just your lunch.
Business forms are the same. Think of the camping bag as a corporation. There are times when you absolutely want to have a big, heavy corporation for your business, but if the benefits of having all that structure is less than the weight of it, don’t incorporate.
There are a number of considerations when you’re deciding whether or not to incorporate your business, here are my top five:
A corporation is a distinct legal entity separated from you as a person. This arms-length distance can be especially important if you are working in an industry that is exposed to risk.
In the unfortunate event that your company is sued the assets of the company are at risk, but the lawsuit would not be able to touch your personal assets. At least in theory… in practice it is not uncommon for the business owner to also be personally named in a legal claim. (if you are concerned about your business liability, you should be consulting a lawyer to have this discussion)
If you need a bunch of money for start-up costs, a corporation will allow you to sell equity (shares) in the company or to take on debt to generate the funds you need. Except that a new corporation has the about same credit rating as a teenager who just moved out, so loans can be a challenge.
As a sole proprietor, you’re limited to your savings or the amount someone (like a bank or your Grandma) is willing to lend you.
Are you in business for life, or planning to make fast money and a quick exit?
A sole proprietorship isn’t transferable. Somebody can buy your individual assets (like your equipment, website code, and rights to your trade name), but the business itself can’t be separated from the owner.
A corporation has shares, and shares can be transferred. It’s by selling shares that you’re able to sell a corporation
and everything that goes along with it. You can sell the assets of a company, but then you’re left with shares of a company with no assets, so that’s a whole other conversation.
As a sole-proprietor all your business income IS your personal income. Technically, there is no dividing line. (Though, for the sake of your sanity and success, I really recommend keeping very separate records for yourself and the business)
Your personal taxes and bookkeeping will become much more complicated than you may be used to as an employee.
When you incorporate, the tricky part is then actually paying yourself for your work. As an individual you’re taxed on any money you pull out of the corporation. That means for the corporation to be worth it, the total amount of taxes paid by yourself and the corporation needs to be less than if you paid tax on all of the income personally.
A corporation is a separate legal entity from yourself, which means you need to file a separate tax return. These are not easy returns, even if the company didn’t do much in the year. You’re going to need an accountant to prepare the taxes, and it won’t be cheap.
There are a few tax planning opportunities with a corporation, but if you’re not making a certain level of income, it doesn’t matter.
It’s a paperwork-intensive process to incorporate a company and it takes a little while. You have to file annual reports whether or not the corporation had any business activity. It also must be closed (which means still more paperwork) if you ever wanted to quit.
A sole proprietor on the other hand, can just start doing business (make sure you have the proper licenses) and can stop whenever they want to. There’s a lot more flexibility there, so if life gets in the way, no big deal!
My general recommendation is to start out as a sole proprietor and only incorporate when it becomes beneficial for you. This article is by no means an exhaustive list of reasons for or against incorporation. If you’d like to chat more about this, I’d be happy to help you out https://www.kirkcpa.ca/contact
When you start out on a business adventure, just grab the small backpack that’s already in your closet and head out the door. While you’re out, if you decide to take on a much longer and more complex adventure, you can always go by the camping store get yourself a bigger backpack with everything you need in it.
P.S. If you’re on a business adventure come join us in the Captains Harbour community! We’re business captains that have come together to chat and get support on all things accounting and taxes!