One of the most common questions early startups ask is when should they incorporate their business. Switching business structures can sound like a complicated process, but it’s pretty straightforward if you understand the structure you’re switching to. For many businesses, operating as a sole trader or partnership becomes unfeasible once the business grows to a certain level. In this article, we’ll explain the signs to look for that it’s time to register your business as a company.
When is the right time?
There is no golden rule when it comes to incorporating your business. Rather, the time to incorporate will vary depending on the specific circumstances of the business. There are however, a number of factors that will influence the decision to incorporate. One good way to look at it is by determining what your goals for your business are.
To put in in perspective, it may not be wise to incorporate a hobby. Rather, incorporate when you are serious about making your startup a profitable business. In the early stages of your start up there’s a lot to consider. This includes developing your product, validating your idea, and finding your market fit. Although you may not want to think about the legal issues just yet, at some point you will need to incorporate your business if you want it to be successful. Here are some common situations where it’s probably time to incorporate.
1. You start taking on risk
One of the key reasons to incorporate is to help protect the owner or owners from personal liability. A company is a separate legal entity and therefore creates a corporate veil between the owners and the company. If there is ever a dispute or issue, the company can insulate the owners from liability. By contrast, sole traders assume all liability. This means that you are responsible for any debts your business owes.
Cash strapped startups may want the ability to pay in equity rather than hard earned cash. To do this, a formal share structure must be sent up. Company ownership is held by number of shareholders, whereas a sole trader is the sole owner of their business. As part of the incorporation process, each company will have a limited allotment of shares. These shares can stay between the owners of the business. However, these shares can also be given to investors or others.
3. Business partners
A business having more than one founder means that there is always the potential for disputes. However, you can manage this problem if you incorporate your business. After you incorporate, ownership will be allocated through shares. The owners will then understand that their investment in the company is determined by the number of shares they own.
It is much easier to raise capital if your business is under a company structure. Many investors prefer to invest in an incorporated business as they know that there is a formal structure set up in order to accept their investment. Also many startups are short on cash and often need to pay employees and partners in equity rather than cash. Although it is possible to have pre-incorporation agreements to grant equity upon incorporation, it is simply easier to incorporate a company and grant stock options or equity to satisfy these promises.
5. Tax considerations
Corporations are taxed at a lower rate than individuals. If you had any other business structure (sole trader or partnership), then you would need to pay taxes on your personal income tax statement – even if that money is staying in the business. This can become quite costly, especially if your business is bringing in a decent profit. Incorporating a business will prevent the owners from paying tax out of their individual income.