So you currently have your own business and you're pondering over whether or not you should incorporate it, or carry on as a sole trader?
Before you make the incorporation decision, you need to consider all of the advantages and disadvantages that incorporating brings.
This article will set out to explain the benefits and downsides to incorporation, starting with the benefits ...
Benefits of Incorporation:
Personal Liability Protection
An incorporated company is a separate legal entity responsible for its own debts. Shareholders only have responsibility for servicing debts and liabilities up to the value of their equity in the Company.
Creditors of a corporation can only seek payment from the assets of the incorporated business and not from the personal assets of shareholders, directors and officers.
As a small business owner of a non incorporated company, your personal assets are at risk if your business fails to service it's debts.
Personal liability protection is therefore a major benefit of business incorporation.
However, owners forming new corporations with small amounts of invested capital may well be asked to provide personal guarantees that credit will be honoured to reduce the risk of the lender.
Also, owners of incorporated businesses are required to personally ensure that the company makes its required tax repayments.
Protection From Legal Action
As with personal liability protection from debts above, the personal assets of the company's owners is protected by the separate legal entity status in cases where the incorporated company faces legal action.
However, owners can still be held personally liable in cases where the company is found guilty of criminal negligence.
Some incorporated businesses can enjoy lower taxation rates following business incorporation compared with partnerships and sole traders. One way of achieving lower taxation is to minimise the salary paid to the owners to reduce higher rates of personal taxation, and draw income from the business in the form of dividends which are taxed at a lower rate.
Obviously professional advice from a qualified taxation expert should be sought in all instances as all personal circumstances are different.
Other taxation benefits of incorporation are that once incorporated, many additional items of expenditure become tax deductible. For example medical expenses, entertainment expenses, vehicle and travel costs, recreational facilities and pension costs all become tax deductible. This can be a significant cash benefit. In particular money placed in an approved pension plan is tax free as is the funds growth.
Raising New Capital
Once you've incorporated your business, the ability to issues shares simplifies the process of raising capital investment. It's also easier to get loans and other finance approved from financial lending institutions if you are an incorporated company.
The existence of shares also simplifies the sale of your business in the future. Also should an owner or director die, the business can continue to operate indefinitely.
Having the words Inc or Corp in your business name gives a positive perception of long term financial stability.
Disadvantages of Incorporation:
Once incorporated, earnings are subject to double taxation, whereby, company profits are taxed, and then the dividends paid to shareholders from the "net" profits are also taxed.
With a non-incorporated business, the income the owner receives from the business is only taxed once. Double taxation can be avoided if the corporation is registered as an "S-Corporation"
Statutory Compliance Costs
Compliance with legal and accounting requirements places a significant burden on companies in terms of staffing, cost and time. There are also fees associated with the initial company incorporation, and ongoing operations.
Loss of flexibility The separate legal entity status of incorporation also means that the company finances are separate from the individual's, therefore the individual cannot "borrow" money from the accounts of the corporation, and statutory requirements in general reduce the flexibility of what can and can't be done with the business and its finances.
The above are some of the key advantages and disadvantages that you as a business owner need to consider before you begin the process of incorporation. You should always seek legal advice as all cases are different.
Richard Taylor MBA is a Chartered Management Accountant and Company Director with a specific interest in small business start ups. Click on the following link to learn more about the pros and cons of becoming incorporated. http://www.incorporate-my-business.com