Here are five questions you should ask yourself when deciding whether to incorporate your small business in Canada.
If the answer to any one of these questions points towards incorporating, then that’s probably a good enough reason to take the leap. But if all of the answers point to no, then it’s probably best to hold off on incorporating for now.
How much excess cash am I generating with this business?
By excess cash, I mean money that (i) doesn’t need to be reinvested in the business and (ii) that you don’t need to pull out of the company for your personal expenses.
If you have excess cash you can keep in the corporation, then incorporating could offer you a tax deferral opportunity. The corporation has a lower tax rate, so if you leave the excess cash in the company, you’ll have a bigger pool of money to invest and grow. If you were to take that money out of the corporation, it would be taxed at a much higher rate, leaving you with a smaller pool of money to deploy and grow.
That’s where the tax deferral benefit comes in. You can invest that excess cash from within your corporation and thereby have more cash available for investment (or you can move the funds to a holdings/investing company by way of dividends or loans).
Over time, investing a larger pool of cash held in your corporation will give you increased returns (even after you take the income out and pay personal tax rates on it) than you would get if you were investing a smaller pool of personal cash.
If your business is not generating excess cash, incorporating will probably not offer you substantial tax benefits.
What is the worst thing that could happen with my product or service?
Imagine the worst-case scenarios for the services and/or products that you sell. How serious are those worst-case scenarios? You should think about the worst-case scenarios stemming from your customers but also from employees, contractors, and suppliers (if you have any).
Here’s a more specific question you can ask to help your thinking: If someone were to sue me for the worst-case scenario, how much might they sue me for? Is it $2,000 or $2,000,000? If it’s $2,000,000, it could be devastating and life-altering for you. In that case, incorporating would probably be worthwhile to the extent that it can protect you from personal liability (more on that below). If the answer is $2,000, it might not be worthwhile to incorporate.
Incorporating is beneficial when the potential risks are high because corporations are treated as separate legal people in Canada. So, the liabilities of the corporation are separate from the personal liabilities of the people involved in the company.
There are exceptions to this, however:
- If you do anything fraudulent or grossly negligent with the corporation, then courts can look past the separate legal personhood of the corporation and pin some or all of the liability onto you personally;
- As a director and officer of a corporation, you take on personal liability for the liabilities of the corporation. For example, if the corporation has unpaid wages, taxes, and environmental liabilities, all of those are situations where the directors can be personally liable to cover the corporation’s expenses.
Of course, incorporating in and of itself is not enough. The first and most obvious thing you need to do is take all the steps you can to ensure that your services and/or products do not cause any harm! That, above all else, is the most important thing to do.
Also, keep in mind that some of your business risks can (and should) be mitigated in other ways. For example, you can purchase business insurance to cover off certain liabilities. When your business risks are on the lower end of the spectrum, it might be best to purchase insurance (which you’d probably want anyway) rather than spending your limited resources on incorporating and everything that goes along with it. In some cases, you must purchase insurance, such as workplace safety insurance mandated by the province in which you operate.
Another way to mitigate your liability is to make sure you put in place contracts or terms of use with your customers and explicitly include terms that limit your liability.
Will anyone other than me have a stake in the business?
Incorporating might be a good idea if you are going into business with one or more people.
There are various ways of structuring a collaboration amongst multiple people: partnerships, cooperatives, etc. However, corporations are particularly popular vehicles for collaboration. They were developed as a legal structure to promote innovation and risk-taking and give groups of people a legal structure for sharing the risks and rewards.
You should consider, first and foremost, whether there will be multiple people who will be risking money, resources, or time with an expectation of sharing in the rewards of the enterprise. If so, those people would probably expect to be shareholders if the enterprise were incorporated. Incorporation gives the group a good framework for cleanly allocating each person’s portion of the risks and rewards and isolating the liabilities associated with the enterprise in the corporation.
Suppose you will be building out a team of people to assist with your business (other than the shareholders referred to above). In that case, that’s another reason why you might consider incorporating. The corporate structure helps to provide a framework for people to work together with a hierarchy of roles: Shareholders, Directors, Officers, and employees. You might find it easier to structure the collaboration and assign clear roles and responsibilities if you do it under a corporate structure.
Will I be able to get a big grant for funding opportunities if I am incorporated?
Some people incorporate because it is a prerequisite to be eligible for certain government grants, funding, and programs.
This is a tricky one. You need to be very thoughtful about whether or not you incorporate for this reason alone. If the grant, funding, or program is of relatively low value or short duration, then think twice about incorporating it just to access the opportunity. After the opportunity is exhausted, you will still be left with the corporate structure and its upkeep (though with tobuso.ca, those costs and headaches are significantly reduced). To learn more about costs after incorporation, see our article here.
Also, remember that many government programs require significant paperwork and reporting… which wastes valuable time. If the opportunity isn’t big or long enough, it might not be worth the hassle.
It is also important to find out in advance whether there are any additional requirements other than being incorporated. For example, some opportunities require you to have a certain number of people on payroll, a minimum annual gross revenue figure, or similar requirements. For that reason alone, ensure you know all the conditions and requirements of the grant, funding, or program opportunity before you jump into incorporating.
Am I planning on selling my business in a few years?
This question is a bit of a stretch because it will only apply to a small segment of business owners. Still, if you plan on selling your business in the medium term (let’s say 3 to 5 years from now), consider incorporating sooner rather than later.
The reason is this: When you sell the shares of a Canadian Controlled Private Corporation (CCPC), under very specific circumstances, a lifetime capital gains exemption can be applied to the sale of those shares. So, if you are incorporated and you are able to sell your business a few years down the road and if you are able to structure the sale as a share sale (as opposed to an asset sale) and if you meet the requirements for the lifetime capital gains exemption (there are many and they are complex, so you’ll need a tax advisor at that time) then you have a chance of saving hundreds of thousands of dollars in taxes. So the benefit is a big one.
We hope that this article has been helpful!
If you have gone through the article and decided that incorporation is right for you, you can easily take the next step right now. We’ve designed a comprehensive incorporation package that is both fast and affordable; just follow the prompts, and you’ll be on your way!
And if you would like to learn more, please drop us a line or book a call.
