What Are The Benefits of Incorporating?

1. Reduce Exposure to Personal Liability

The main benefit founders seek when incorporating is protection from personal liability exposure related to the debts of business. Without incorporating, sole proprietors and general partners in a partnership can be personally and jointly responsible for the liabilities of a business including loans, accounts payable and legal judgments. In a corporation, however, shareholders are typically not liable for the company’s debts and obligations. With some exceptions, shareholders are usually limited in liability to the amount they have invested in the corporation. There are also instances where the directors and officers of a corporation can be personally liable for the actions (or omissions, like failing to pay corporate taxes or wages) of the corporation. 

3. Raise Money to Finance a Business

The corporation is also the best vehicle for raising money to finance a business. However, given the complexity of securities laws, its best to hire a lawyer to help you issue shares to investors. Keep in mind that as a startup, you cannot head out into the market and issue shares to whomever you desire. More on that in a moment.

2. Tax Benefits

The second reason founders incorporate is to take advantage of tax savings. Corporations, like individuals, are subject to both federal and provincial income taxes. However, corporations are taxed differently when compared to individuals. While individuals are subject to progressive income tax rates, corporations are subject to flat rates of tax. The rates of tax applicable to corporations are lower than most individual tax rates. While incorporating is not always tax efficient, in many instances founders elect to incorporate just for the personal liability benefits alone. 

Other Reasons to Incorporate

Aside from the three main benefits, other benefits of incorporating include:

  • Transferable ownership. Ownership in a corporation is easily transferable to others by selling all or part of your equity.
  • Durability. A corporation is capable of continuing indefinitely. Its existence is not affected by the death of shareholders, directors, or officers of the corporation.
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Why Have Different Share Classes?

Not all shares are created equal. Corporations can issue different types (or classes) of shares with different rights attached to them. Having different classes of shares can be used for a number of different reasons but more often that not, they are used to manage the amount of control shareholders have in relation to their ownership of the company.

For example, in some circumstances, founders will not want investors to have voting rights when it comes to appointing members of the board of directors or managing the company.

The various kinds of preferences, rights, and conditions that may be attached to shares are virtually limitless and can effect the value of the shares or what an investor or co-founder is willing to pay for them.
For a sole founder, the company is often incorporated with only one class of shares, which are usually designated as “common” or “Class A” shares. The decision to issue other classes of shares hinges on your company’s circumstances, particularly whether you intend on raising outside financing from other investors or whether you intend on hiring an employee and offering part or all of his or her compensation in the form of shares.

Incorporation documents setting out share classes can always be rearranged and the addition of another class of shares can be deferred until such time as they are necessary.

Of the various factors to be provided in the articles when establishing the rights, privileges, restrictions, and conditions attaching to shares, the following major share conditions should be considered, if more than one class of shares is to be created:

  • cumulative, non-cumulative, or partially cumulative dividends, and specific dividend rates;
  • preference as to payment of dividends;
  • preference as to repayment of capital upon dissolution;
  • participation in the distribution of the corporation’s assets upon dissolution other than with respect to return of capital;
  • right to elect all or part of the board of directors;
  • right to convert into shares of another class;
  • redemption of shares at the option of the corporation or retraction of shares at the option of the shareholder;
  • purchase of shares by the corporation for cancellation; and
  • conditions, restrictions, limitations, or prohibitions on the right to vote at shareholders’ meetings.
Where to Incorporate (Federal vs. Provincial)

Founders must consider which jurisdiction to incorporate in. Generally, an Ontario lawyer will incorporate a business “provincially” under the Ontairo Business Corporations Act (“OBCA”) or “federally” under the Canadian Business Corporations Act (“CBCA”).  Generally, most web based technology companies prefer to incorporate federally and register their businesses provincially as need be.

Naming the Corporation

Naming a company can be very difficult. Wires Law advises founders on their proposed corporate name and gives them the tools to help them make sure their name complies with provincial and federal laws. Certain words cannot be used in a corporate name including words contrary to public policy or suggest a connection with government, universities or political party. When incorporating a named business you must complete a NUANS search of existing companies, maintained by Industry Canada. Under both the OBCA and the CBCA, the proposed corporate name cannot be the same as or similar to that of any known entity (or trademark), if the use of that name would be likely to deceive or be deceptively misdescriptive.

You should also ensure a suitable web domain is available.

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