As an entrepreneur, the easiest way to pull the trigger and get started is as a sole proprietor and many choose to kick things off down this path. It’s inexpensive to set up and fairly straightforward so why not?

However, as your business thrives and grows, there comes a point where you’ll need to consider incorporating. 

How do you determine when is the right time? And what are the pros and cons of switching?

Benefits of a sole proprietorship

Well firstly, let’s take a look at the benefits of carrying out business as is. As a sole proprietor you’re going to have:

• Simpler taxes to file – The income you earn from your business can be declared on your personal income tax return, and you’re simply taxed accordingly. No separate corporate tax and the complexity that comes with it.
  
• Tax advantages (if you’re at a loss) – If business isn’t booming or you’ve had to put up a large upfront capital to get things going and haven’t turned a profit yet. You can deduct these losses against your personal income to take advantage of a lower tax bracket rate.
  
• Less paperwork – You’ll never need to prepare alternate financial statements, maintain minute books, and all the other complicated documents that are necessary for corporations.

So why Incorporate?

Well, at a certain point your business may go from a small side-hustle to one that’s generating good revenue, profits, and with many employees and customers. This can mean two things:

• • Legal risk: This is the most important factor. Incorporating your company has the main benefit of reducing any personal liability as your business is now a separate entity. This means your personal assets are now protected from any lawsuits or bankruptcies.   For example, if someone gets hurt in your office and sues your business, as a sole proprietor your personal assets may be used to pay for damages. However, if you’re incorporated, any claim to damages can only be paid using the business assets. The reverse is also true, if you personally get into a car accident and are sued for damages. As a sole proprietor, they are entitled to your business assets as well to pay for the damages. If incorporated, they’d only have claim to your personal assets.   As a business grows, exposure to risk grows with it and is one of the key driving factors for incorporating.
    

 

• Tax savings: The other key factor is tax savings. Corporations in Canada pay a much lower tax rate than individuals would. As a sole proprietor you’d be charged using personal tax brackets and this can mean if you’re earning collectively over $90,000 annually, a tax rate of 40%-50%. As a corporation however the tax rate is 15.5% which can be hugely beneficial.
  By employing different tax strategies such as Income Splitting, you can also yield some savings on your personal income tax return as well. 

 

 

• Shareholders: The other advantage of a Corporation is the issuing of different classes of shares. This can be a lucrative way to grow your business and attract key talent where you’d like to offer equity in addition to salary in order to have them join the company as an employee.   Moreover, should you pursue external funding. Most investor groups will require an incorporated entity to close the deal.

 

Sold? Well there are a few downsides…

With these legal protections and tax advantages comes the complexity of maintaining a corporation.

This means a few things:

 

• It’s complex to maintain: Incorporating comes with the downside of lots of paperwork and maintenance of these documents. You’ll need to maintain minute books and corporate bylaws, a register of directors, and file annual corporate financial statements.
  

 

• It’s expensive: All that complexity means it’s also very expensive. While kicking off a sole proprietorship can in some provinces be free, or very cheap ($60). Incorporating can set you back $250 just for the basic registration. After this, you’ll need legal and accounting support to help file relevant paperwork that can surpass annual costs of $3000.

 

 

• It’s harder to close your corporation: Moreover if you decide to close a corporation, this can be expensive involving lawyers and accounts to dissolve the corporation, and is a time-consuming procedure involving lots of paperwork. 

As with any decision, there are pros and cons and it really all ‘depends’ on your situation. A good rule of thumb is to think through the complexities of your business, the profit it generates, how many parties are involved in running the company, and if all look like sizeable factors, then incorporating the logical next step.