I’m often approached by people who want to start a business. Starting your own business (or buying one) can be very rewarding, but also quite daunting. What should you know, and where do you start? In this two-part blog series, I will address these questions by focusing on the most frequently asked questions, and providing sound advice for anyone starting a business. Part One will focus on the business considerations. In Part Two, I will focus on the tax considerations.
I hear people say, “I’m incorporated”, but What does that mean?
Let’s begin by looking at the different types of arrangements you can use for your business. The simplest arrangement is a sole proprietorship. This means you are running a business, but that you and the business are one and the same. You have limited (if any) legal protection against creditors, or people wronged by your business. You also have the least tax planning strategies available to you.
The second type of arrangement is a partnership. Being in a partnership is similar in many ways to being a sole proprietor, except that you are working with others in a contractual relationship. You collaborate and share the benefits, including cost sharing, but you have legal and tax implications similar to a sole proprietorship. Limited Liability Partnerships, or LLPs, have some different implications, which will not be addressed.
The final option is to incorporate. Incorporation is known by different names and can be complex, but it basically entails registering the business as a separate legal entity (also called a “legal person”) with the provincial and/or federal government. You will be a shareholder of the corporation. As a shareholder, you enjoy legal protection from most activities which could harm the corporation, and you are afforded many more tax planning strategies. Corporations can also be used in group structures, where one corporation is the shareholder of another corporation.
Deciding which structure to use for your business is critical. To ensure you have considered all aspects, it is highly recommended that you speak to several professionals before making your decision. Oikonomos Chartered Professional Accountants are always happy to provide sound advice during this decision-making process.
That makes sense, but doesn’t it cost a lot of money to have a corporation?
Yes, you’re absolutely correct that the costs for incorporation are higher than not incorporating. The compliance costs, such as filing information with the regulators, preparing tax returns, preparing financial statements, and more, generally do cost more for a corporation or partnership than for a sole proprietorship. In a sole proprietorship, you are generally only required to complete a few additional schedules on your personal income tax return. For a partnership, you must complete similar schedules on your personal income tax returns, and there is also tax reporting required for the partnership. For a corporation, you are required to prepare a corporate income tax return, and in most cases, will also need to prepare at least a basic set of financial statements. The complexity of a corporate tax return (and a partnership return) will require the services of a professional accountant. If you have financial statements prepared, you will also want these completed by a professional accountant. These services will cost more than the schedules on a personal tax return. However, the additional tax planning strategies alone should more than compensate for the additional cost of a corporation. In other words, the money you can save with tax planning will exceed the extra cost of being incorporated (in most cases).
Okay, But let’s say I run a small home-based or solopreneur business. Should I incorporate?
In the early years, many businesses incur losses while they are building their client bases or products. If you are earning other income (e.g. salary from an employer) and your business is making losses, then it is better not to incorporate. The reason for this is that the losses made on the business can be deducted from any other income you’ve earned, resulting in a lower tax bill. However, once your business starts making money, you should reconsider incorporating. In very simple terms, when you can earn $80,000 of income, but only use $60,000 personally, the greater extra cost from incorporating is covered by the tax savings. Once you have reached this break-even point, you are better off being incorporated. There is also a second income trigger point. If you maximize your RRSP contributions each year, you will reach the maximum contribution room at approximately $145,000 (at 2017 tax rates). Once you have reached this income level, incorporation becomes imperative for the protection and tax saving opportunities on every incremental dollar earned.
Great, thanks. So, let’s assume I’m going to incorporate. Should I bring in business partners?
Bringing in business partners can be a rewarding experience, or one of the worst decisions you ever make. The answer to this question is not only complex, but ultimately needs to be made on an individual level. Since discovering the book The Partnership Charter, I have been recommending it to anyone who asks me this question. The book does a great job addressing the pros and cons of bringing on business partners, and provides access to resources that will guide you if you do decide to bring on business partners.
If you bring on business partners (even if they are family members), it is highly recommended that you obtain a legal document called a Unanimous Shareholders Agreement, or USA, for short. This document stipulates how conflicts will be resolved, how and to whom any business may transfer their shares, how the value of the share will be determined, and much more. A USA is like having a will and a prenuptial agreement combined. It is intended to protect all parties in the event of a major change in circumstances (e.g. the death of a business partner, selling out by some or all the shareholders, etc.)
That’s great advice, I’ll read the book. I think I want to incorporate. Can I do it myself, or is it better to have it done for me?
Incorporating a company can be done yourself at any registry office (the same place you get your vehicle license) for under $500. If you incorporate through a lawyer, it will usually cost between $1,000 and $1,500 for a simple corporation. In the long run, the incremental cost of using a lawyer is worth it. When you pay a lawyer to incorporate, you pay for two things: First, their familiarity with the registration process, which means they can do it quickly. And second, their expertise in setting up the share capital structure of the corporation, and the bylaws, which each corporation must have. The biggest mistake I see with self-incorporated companies is that the share structure set-ups are less than ideal. To optimally use the available tax planning strategies, you need to ensure the share capital of the company is structured correctly. This is one of the reasons you want to use a lawyer and a professional accountant to incorporate.
There are many other considerations to take into account when starting a business, such as succession planning, winding up a business when you no longer want to use it, estate planning, and more. If you require further advice, please feel free to email or call us for a free consultation (maximum one hour).