A corporation or a partnership?
That’s a question facing a lot of founding teams early in their startup life, and it keeps coming up until they finally decide to incorporate.
As with so many business decisions, the correct answer depends on your circumstances. So the best advice I can give is to make sure you’ve considered all these factors before you act:
- Do you need incorporation to receive non-dilutive funds? Some funding organizations will only allot grants, loans or other contributions to corporations and not partnerships. And in the early stages, non-dilutive financing can be the difference between launching and sputtering. When meeting with support agencies, nail down whether you have to incorporate to receive funding. It may override all other considerations.
- Would you benefit from limited liability? There are legal risks in any enterprise, but some more so than others. If you’re soon going to be selling a product for instance, you may want to incorporate just because the company rather than the partners would assume the legal risks. Do your research though. Incorporation won’t completely protect you from all liability all the time.
- Is there a tax advantage for incorporating? By the time your company exceeds $60,000 in revenues, the tax code will make you take a look at incorporating. The reason is that corporate income tax at that level for small business is less than personal income tax. You and your startup would likely pay less in taxes if you incorporate and draw a salary.
- Do you need to incorporate to protect your intellectual property? No, but some founders choose to incorporate simply because a corporation is a better vehicle for holding intellectual property than a partnership.
- Are you ready to split the equity? This may be the most complicated issue and will be the subject of an upcoming post. First, you have to nail down the initial distribution of founders` shares before you even consider incorporation. If the founders bicker about share allocation after incorporation, it will likely be damaging to the business and costly to sort out. Once you decide to incorporate, make sure you use a simple share structure. It’s okay to have a class of common shares, and a second class of non-voting shares for employees and the like. But more exotic classes, such as preferred, are generally inadvisable for a startup that is considering rounds of financing.
- Have you decided on a federal or provincial incorporation? Incorporating federally may cost a bit more, and may prove more palatable to American investors and/or potential takeover partners. It’s not a big deal, because it is fairly easy to transfer incorporation from provincial to federal and vice versa.
- Have you sought professional advice? Sometimes founders incorporate on their own – that is, without professional advice – and I find they usually don’t save money so much as defer payment. Quite often, they have to pay later to prepare the corporate records and undo mistakes they made by incorporating themselves. Seeking professional help to incorporate generally costs about $600-$1000 in professional fees and $300-$500 in government fees. Several law firms include incorporation as part of an affordable startup package that can help you avoid pitfalls.
In summation, don’t rush it. The incorporation process should be a relatively simple one, as long as you take the time to avoid sundry pitfalls.
Editor’s note: The Canadian Startup Lawyer blog by Rob Cowan, Partner at McInnes Cooper, appears monthly on Rob’s blogging site, StartupLawyer.ca, and Entrevestor.
