A corporation is one of the most common ways of structuring a business in Canada. Incorporating a business can be done at the federal or provincial/territorial level through the filing of the articles of incorporation (documents that outline the type of business, its shareholders, directors, and bylaws). A business can be a private or public corporation. The distinction between the two is that the former cannot sell shares to the general public while the latter can. Once a business is incorporated, it is considered a distinct legal entity that is separate from its shareholders.
The benefits of incorporating a business are many, including: the creation of a legal entity, limited liability for corporate founders, lower tax rates, a more conducive vehicle for raising capital, and perpetual existence.
Pros of incorporation
1) Creation of a legal entity separate personality
Through incorporation, a business develops a ‘separate personality’, which essentially means that it has almost all of the same rights as a person. The business can acquire assets, obtain loans, enter into contracts, and can even sue.
2) Limited liability
Incorporating a business effectively limits the liability of its shareholders to the amount of their investment in the company. A corporation’s shareholders are not liable for any debts it may have. Creditors are barred from suing shareholders for the incorporation’s liabilities. The exception to this rule is when shareholders have made personal guarantees for the corporation’s debts.
3)Lower Tax Rates
Generally, the corporate tax rate is much lower than the individual tax rate, which means that by is much lower than the individual tax rate, which means that by incorporating a business, one can reap advantages of this lower tax rate. However, unlike sole proprietorships and partnerships, business losses cannot be deducted at a personal level.
4) Access to Capital Financial
Institutions often offer corporations a lower rate to borrow capital than they do to other types of businesses. Additionally, corporations can offer bonds or shares to raise capital for the business where other types of businesses must rely on the capital they possess and any loans they can secure.
5) Perpetual existence
A major benefit of incorporating a business is its continued existence even if its directors/shareholders were to die. Unlike sole proprietorships or partnerships, which ceases to exist once their owners are dead, a corporation’s ownership transfers to the heirs of its shareholders. This stability is advantageous in two ways; first, it allows for more favourable financing and second, it allows for long term planning of the business.
Cons of incorporation
Higher start-up/continued costs
There are federal administrative requirements for federally incorporated business that can add to the costs. For example, a federally/provincially incorporated business is required to maintain corporate records, including but not limited to annual returns, notices of any changes in the board of directors, and any articles of amendments. These tasks are usually carried out by lawyers and auditing firms that charge for their services. Additionally, there are added costs with electing/hiring directors and officers to manage the company.
Complex Structure
As previously mentioned, a corporation is and separate legal entity. The activities of the business must be carried out by persons with an interest in the business who are elected to act on behalf of the corporation. There are three categories of people that can act on behalf of the corporation; shareholders (depending on how many shares of the company one owns), directors, and officers. The shareholders of the corporation use their voting powers to make decisions about the business. Directors are voted in by the shareholders and they supervise the management of the corporation. They also elect the officers. Officers are responsible for managing the business and ensuring its success. Amongst the officers are the CEO, CFO, and President.
Difficult to secure capital
Sometimes it can be difficult for a corporation to secure loans. Because a corporation’s shareholders cannot be held liable for its debts, financial institutions hesitate to provide loans to corporations that are not well established and/or do not have assets. Shareholder(s) may be required to provide personal guarantees for the corporation’s debts, which would allow the creditors to sue the shareholder(s) for the liabilities of the business upon default of a loan.