If you're an entrepreneur with an established small business, you may be considering the next step for your business. The main question will be whether you continue to trade as a sole trader or do you incorporate your business?
What are the consequences of either decision? Basically if you carry on as a sole trader you will continue to put your own personal assets at risk should your business incur financial difficulties, whereas once incorporated your business becomes a separate legal entity, and as such your personal assets are separated legally from those of the company, and therefore are protected.
So the significant benefit of small business if the personal liability protection incorporation affords the owner. The personal liability protection comes about because the new incorporation is treated in law as a totally separate legal entity. Therefore as the owner you receive protection from the business's debts and liabilities in the event that the assets of the business fail to cover those liabilities. In effect, as a shareholder of the newly incorporated company, you will be liable only for servicing the debts of the business up to the value of your equity investment.
The second significant benefit of small business incorporation is that it becomes a lot easier to raise additional capital investment following incorporation should you need extra cash to finance the growth of your business. Once incorporated, you're company will have a formal structure for issuing and valuing shares. This simplifies the process of raising additional capital investment through a share issue considerably.
It also makes it easier to value and sell your equity in the company when you wish to either sell or leave the business.
Should you wish to borrow rather than raise capital, incorporating you business will help as it gives your company more credibility with lending institutions, making future borrowing easier to attain.
There may also be tax advantages to incorporating your small business. Incorporated businesses can enjoy lower taxation rates than partnerships and sole traders. Therefore by manipulating salary and dividend payments, you can effectively pay less tax once incorporated. Additionally, many additional items of expenditure become tax deductible.
The above are some of the key benefits, but what about some of the negatives of incorporation?
Once incorporated, you will have to comply with a lot more statutory and accounting requirements. These additional overheads can be a significant burden and cost to your small business. You will also experience a loss of flexibility in the way that you run the business. For example, you will need to adhere to strict laws that govern your company's finances, such as you will not be allowed to "borrow" money from the accounts of the business for personal use.
Another downside could be double taxation. Double because your company profits are taxed initially, and then the dividends paid to the shareholders from the "net" profits are also taxed. So whilst the individual shareholder can benefit from paying less personal tax as discussed above, the total tax paid after incorporation can be more.
When considering incorporation for your small business, you should always seek professional advice from a qualified accountant or lawyer.
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