Every business decision involves some legal consequence. Whether your business is operating from a home or office tower or whether it is a computer-related business or not, you face the same potential legal risks as any other business. It makes a strong argument for considering the benefits of incorporating.
What are the main business risks that could result in you being sued? The most obvious is debt: your business owes money it cannot pay. Then comes breach of contract – when your business commits to doing something in a certain time frame, but for some reason cannot fulfil the bargain. The last is negligence: you could be sued if someone using your service or product; is injured physically or suffers financially. No matter how hard you try to avoid these risk areas, problems can occur.
In my opinion, incorporating your company is sometimes essential and always advisable to consider. It is the cheapest peace of mind you can buy. Incorporation means you create a limited-liability company to carry on your business under federal or provincial law. If your company is sued, the liability is almost always limited to the assets of the company. If your company has no assets, the creditor with a judgement against it is out of luck.
You can incorporate by yourself or go through a lawyer. Doing it yourself costs about $300 (mainly in fees to the government). Going through a lawyer adds about $350 to $500 in legal fees, but could help you wade through key issues of corporate structure and other legal strategic planning. You can contact the lawyer referral service in your province to get names of lawyers who do corporate (business) law. The initial consultation is free or at a nominal fee (e.g. $10).
If you are bringing in partners, complete a shareholders’ agreement when you incorporate. This can cost $500 or more, but it’s money well spent as it sets out formulas for resolving disputes.
The penalty for not limiting your liability can be huge. Consider two business people I’ve encountered who could have benefited from incorporating.
A computer consultant underestimated his costs when he signed a large fixed-price contract. He quit half-way through the project as he couldn’t afford to complete it. The client sued him personally for losses due to breach of contract. The entrepreneur lost his house and declared personal bankruptcy. The trauma caused a marital break-up – a common outcome.
A computer programmer designed a program that allegedly had flaws and did not perform the functions expected. As a consequence, the client had a lot of down-time and had to have a new program developed. The client sued. The programmer had to sell his home and declare bankruptcy.
Incorporating probably wouldn’t have saved the businesses. But it might have saved the owners’ homes – and maybe even their marriages. Here’s why I am sold on the benefits of incorporating.
Legal benefits: You can protect yourself as a shareholder from being personally sued, as long as you haven’t signed a personal guarantee to creditors, suppliers and landlords. But directors can be sued by statutory creditors, that is, government departments with claims against the company, such as Revenue Canada.
Financial benefits: A corporation has more financing options available. It can attract investors, and it provides more security to lenders because of its ongoing legal structure. When a shareholder dies the corporation can still be carried on, passed on or sold, as a corporation is a separate legal entity. A non-incorporated business ceases to exist as a legal entity when the owner dies. Lenders and investors don’t want that risk.
Marketing: An incorporated business implies prestige, stability and greater resources than an incorporated business. This may be illusion, but it happens.
Tax: There are many tax advantages to incorporation, such as dividing business income between family members by splitting shares, deferring tax on business income, and the capital gains exemption on the sale of the business.
Your accountant may suggest that you hold off from incorporating until you are making more money. There are solid financial grounds for doing so. But the bottom line is your potential liability, which starts the second you begin doing business. If you perceive any risk, the answer is simple – incorporate.
