There are a number of significant benefits that a small business owner should consider when determining whether incorporation is the right path for their business.
We’ll discuss these main advantages below, as well as the disadvantages that embed brings.
To get started, let’s cover what exactly a company incorporation is. When you incorporate a business, you are, as far as the law is concerned, providing a formal legal separation of your own personal assets and those belonging to the business. In effect, your company becomes a separate legal entity in its own right.
What does this mean for you as a small business owner? In very basic terms, it means that if your business falls on hard times and goes bankrupt, you as the owner are not responsible for the business’s debts, because they are owed by the business and not by you. So once incorporated, you can run your business knowing that your savings and personal assets are not at risk.
For businesses with a short business history, poor financial history, or few assets, most lenders will require personal guarantees to be signed to provide additional security. But as the business grows, the requirement for personal guarantees will decrease, because the business itself will have more assets against which to secure financing.
If your business fails after incorporation, shareholders are only liable up to the value of the capital investment made, except for any separate personal guarantees that have been signed. In other words, your liability is limited to your capital investment, so you may lose your investment in the company, but beyond that, your savings and personal assets are safe.
In addition to the personal limited liability protection that incorporation provides, another important benefit is that once incorporated, it is often easier to borrow money or raise more capital investment to finance the growth of your business.
It becomes easier to raise additional capital for several reasons. Incorporation tells financial institutions that your business plans to be around for a long time and gives them a degree of security. Also, after incorporation, your company has established share structures that make it easy to assess the value of the company.
Being able to independently value the company makes it easier to obtain financing, as the company’s debt/equity ratio can be analysed, and the ownership structure itself means that shares can be issued to raise new capital investment. Having a share structure also makes the transfer of ownership easier should the need arise.
Among the disadvantages of incorporation are the additional legal and regulatory requirements you will need to meet, which can be expensive.
Taxes must also be considered. The business structure and the way shareholders and directors are compensated will determine whether or not more tax is paid after incorporation.
It is always recommended that you seek professional legal and financial advice before proceeding down the path of incorporation, and it should be noted that this article is for general information only and should not be relied on.