Today’s post will wrap up our discussion on structural options for your business, and it will focus on the type of legal structure used by many of today’s largest companies: corporations. This is no accident, as corporations offer several unique benefits over other options.
Here’s what you need to know:
Prerequisites: A corporation must be created. This means that one or more individuals (remember, this can mean people or other businesses/entities) to draft a document called the articles of incorporation. This document functions similarly to the partnership agreement for a partnership, as it outlines the ‘rules’ of how the corporation will operate, how decisions are made, and the rights and responsibilities of various counterparties. You’ll then need to register the corporation with the appropriate agency depending on where you plan to locate the business. The specifics vary, but this often costs between $500 - $2500.
Liability: At the root of it, this is the biggest departure between corporations and other legal options, since a corporation is seen as a separate legal entity in the eyes of the law/tax authorities - this means that your corporation may as well be a separate person, as far as the legal system is concerned. As a result, the corporation itself faces the legal exposure that comes with carrying on business activities. This keeps your personal exposure limited to your investment, and your personal assets safe.
Profits & Taxes: The concept of a separate legal entity follows here too. The corporation is responsible for its own taxes, which, in many countries, follows a two-tier system. Put very simply, this means that the corporation pays one low tax rate on profits as they’re earned, and a second low tax rate when the earnings are paid out to other taxable entities, like yourself. The idea is that these two rates combine to be equal to the single, high rate paid by an individual all at once. The key here is that a corporation can control when that second tax hit occurs. By deferring this, you retain more of your money which you can use to generate more profits. Over time, this equates to a huge advantage over a sole proprietor.
Transferring Ownership: When a corporation is formed, shares must be issued. Your percentage of ownership is determined based on the proportion of issued shares that you hold. Shares can be transferred/resold to other individuals to easily transfer ownership interest. This makes it easy to carry on the business regardless of a change in personal circumstances.
It’s easy to see why the corporate structure is favoured by many of the most successful businesses all around us, as it offers two distinct advantages over other options:
Reduced risk exposure - since the business will be viewed as a separate entity in the courtroom, your personal risk of operating this business is basically limited to how much capital you’ve invested into it.
Tax deferral - by controlling when the second tax payment occurs, you have more money with which to grow your business, putting you further ahead than if you operated under a separate entity.
Those two items are why I often recommend new business owners to consider incorporating. While the upfront costs may sting for those with very limited startup capital (in other words; nearly all new businesses outside of the Silicon/VC arena), they pale in comparison to the potential results from an unfavourable legal outcome under one of the other methods. The only common downside to this option is increased complexity which manifests around tax season, but again it’s a small price to pay for the benefits noted above.
With that said, we’ll now be switching gears away from the field of business law to give you a taste of other core topics under the umbrella of business education. Once we’ve laid that groundwork, we’ll put this knowledge to use by examining some real companies and situations in a case study scenario to see these concepts in action.