Which of the following is one of the advantages of forming a corporation?

Owning a small business can be a risky venture. One way to limit your personal liability is by incorporating your business, reports the California Society of CPAs (www.calcpa.org). While incorporation requires more paperwork and expense than a sole proprietorship or a partnership, it offers important legal and tax advantages.

1. Protect Your Personal Assets

Incorporating your business is one of the best ways you can protect your personal assets. A corporation can own property, carry on business, incur liabilities, and sue or be sued.

As a separate legal entity, a corporation is responsible for its own debts. That means creditors of a corporation generally can seek payment only from the assets of the corporation -- and not from the personal assets of shareholders, directors and officers. In effect, that means business owners can conduct business without risking their homes, cars, savings, or other personal property. Owners of a sole proprietorship or partnership, on the other hand, face unlimited liability for both business and personal assets.

2. Have Easier Access to Capital

Raising capital is generally easier for a corporation, since a corporation can issue shares of stock. This may make it easier for your business to grow and develop. If you’re in the market for a bank loan, that’s another reason to incorporate. In most cases, banks would rather lend money to corporations than to unincorporated business ventures. Corporations generally have access to more alternative sources of capital through which they can pay off their debts.

3. Enhance Your Business’ Credibility

The benefits of incorporating go beyond finances. Suppliers, customers and business associates often perceive corporations as being more stable than unincorporated businesses. In a sense, having “Inc.” or “Corp.” after your business name conveys permanence, credibility, and stability, and communicates your commitment to the ongoing success of your business venture. 

4. Perpetual Existence

Corporations are the most enduring legal business structure. A corporation can continue indefinitely, regardless of what happens to its individual directors, officers, managers, or shareholders. This means that by incorporating your business, you may be able to avoid the legal entanglements that could result with other business structures.

5. Gain Anonymity

A corporation can offer anonymity to its owners. If you want to open a small business and don’t want your involvement to be public knowledge, your best choice may be to incorporate. 

6. Other Considerations

As a separate legal entity, a corporation is taxed on its profits. Those taxable profits can be reduced by qualified business expenses, including operating expenses, marketing and advertising expenses, travel and entertainment expenses, and other costs of making a profit. An incorporated business may also deduct employee salaries, health benefits, and contributions to qualified pensions and retirement plans for employees. However, the taxation of corporations is complicated; different corporate structures have different tax advantages and disadvantages.

While incorporation comes with important benefits, it may not be the best form for all businesses. A CPA can help you to assess the tax and other implications of incorporating your business.

Incorporating offers several advantages over sole proprietorships.

• Owners benefit from limited liability
• Ownership interests are easier to transfer
• The life of the corporation can extend beyond that of the founders
• Credibility is boosted in the eyes of partners
• Financing and grants are easier to access
• Tax rates are lower

“It’s the very foundation of your business. Once you’ve laid the groundwork, it will be easier for you to determine how and where you’re going to grow your business and identify the most cost-effective ways to succeed,” says Aliya Ramji, a partner at McCarthy Tétrault and co-founder of MT>Ventures, a wholly owned division of the firm.

Below are the main advantages of incorporating for Canadian entrepreneurs.

Limited personal liability

A corporation is a separate legal entity from its owners. It has “the major advantage of limiting the personal liability of its directors toward the company’s creditors,” according to Aliya Ramji.

For example, shareholders in a corporation are not liable for the company’s debts. If the company goes bankrupt, shareholders are protected, while creditors’ recourse is normally limited to the assets owned by the company.

A creditor would therefore not be able to claim your personal property to pay off any debt unless you provided a personal guarantee. However, personal guarantees are still required by many banks.

Easier ownership transfers

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 interests much easier.

This ability to transfer ownership makes it easier to attract investments. 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.

Unlimited life

The other key advantage that incorporated businesses have is that they benefit from a theoretically unlimited lifespan. When shareholders die, their shares are passed on to their heirs or are transferred via a sale.

Conversely, sole proprietorships automatically dissolve when their principals pass away.

Instant credibility

Incorporating your business can provide an instant dose of credibility to your business. Potential investors, lenders, suppliers, customers and employees will immediately know that you are serious and thinking about the longer term.

That said, incorporating a business does require some additional cost and effort. A corporation needs to maintain a separate set of accounting records from those of its owners. Corporations must also pay annual registration fees and file separate financial statements and tax returns.

However, these inconveniences are worth the effort if your goal is to grow your business into a sustainable, long-term operation.

Improved access to capital and grants

“This mode of operation may also make it easier to raise capital and obtain grants,” says Laura Didyk, Vice President, Client Diversity.

“It can add credibility to your business which may make applying for financing or negotiating with a supplier easier,” notes Didyk, who oversees BDC’s strategy to support Canadian women entrepreneurs.

Corporations will also garner more attention from venture capital firms or angel investors who might be solicited to contribute to the company’s growth.

“The Canadian government offers a number of loan and grant programs that are open only to incorporated businesses,” says Yasmine Chaouni, a manager with Corporations Canada, Canada’s federal corporate regulator.

Lower tax rates

Incorporating also provides tax benefits, and corporations may pay less tax.

“Corporate tax rates are generally lower than personal income tax rates,” explains Stefanie Ricchio, a chartered professional accountant (CPA) and founder of the consulting firm The Modern Accountant.

Provincial or federal incorporation?

Entrepreneurs can choose to incorporate their business in a provincial or federal jurisdiction, or both. The choice depends on the company’s own expansion plans.

“In general, the company will benefit from similar advantages whether incorporating provincially or federally,” says Yasmine Chaouni.

One factor to take into consideration while making this choice is the business’s expansion plan. If you operate a small business locally and don’t plan to expand or have national or international customers, it makes more sense to incorporate provincially.

Conversely, if you plan to expand your activities into other provinces or countries, then it is preferable to incorporate federally. “You will have the advantage of having the same name everywhere in Canada, as well as the flexibility to locate or move your business,” says Yasmine Chaouni.

External advice

Entrepreneurs should not hesitate to seek advice from other business leaders to learn more about the benefits and costs of incorporating a business.

“I owned a business for five years without being incorporated or protected against legal and financial liabilities. I should have talked to other entrepreneurs for advice,” says Ramji.

Looking back in hindsight, she believes that more women could learn from the approach of male entrepreneurs. “Men tend to be more inclined to network and tell others about their business,” she says.

Entrepreneurs can also draw on a vast network of resources, such as chambers of commerce, government economic development agencies and incubator-accelerators, that are ready to assist them in their business endeavours.

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