May 16, 2023 by Ava Aslani
Starting a new venture is an exciting journey that can be both thrilling and daunting, and there are no shortage of decisions you’ll need to make. One of the first will be when (or whether) to incorporate. If your business is a technology startup (which are usually characterized by rapid growth, a need for external investment, and a potential exit event), incorporating a company early on offers a number of important benefits. In this article, we explore what those benefits are.
From an investor’s perspective, the value of a startup is largely based on the strength of its intellectual property. So, it is crucial for startups to have clarity on who owns the intellectual property that is developed or acquired in connection with the business they are operating. Incorporating a company (and ensuring that all of the intellectual property belongs to the company) is the simplest way to achieve this clarity.
When you’re just starting out, it may be tempting to avoid the cost and complexity of incorporating and hold intellectual property in the founders’ names, but this often leads to problems in the future when trying to license, sell, or use the IP as collateral in financing.
By incorporating your business, you’ll be able to assign all of your intellectual property to the company, ensuring that it is protected and owned by the business. This is especially important if you plan to raise money from investors, as they will want to see that the company they are investing in is the one that owns all the intellectual property that is needed to run the business.
Another reason to incorporate your startup is that it makes it easier to obtain financing. Most investors prefer to invest in a company rather than a sole proprietorship or partnership because it provides them with greater protection and more control over their investment. A company can issue shares to investors, giving them a stake in the business and a way to share in the upside. This is much harder to achieve with other business structures.
In addition, incorporating your startup can make it easier to qualify for loans or grants by providing a clear separation between personal and business finances, establishing transparency and accountability, and creating a sense of credibility and legitimacy.
Added Incentive for Investors
In BC, if your startup qualifies to register as an Eligible Business Corporation (or EBC) under the Small Business Venture Capital Act of British Columbia, investors can receive a 30% tax credit from the provincial government for investing in your company. This can be a significant incentive for investors, but in order to qualify, the startup has to be an incorporated entity (among other qualification criteria).
Incorporating your startup also limits the liability of the founders. Owners of sole proprietorships and partnerships are personally liable for all debts and obligations of the business. This means that if the business is sued or runs out of money, the owners could lose their personal assets, such as their homes and savings. When you incorporate your business, it becomes a separate legal entity, meaning the owners are not personally liable for the debts and obligations of the company. They may lose their investment in the business, but their personal assets will be protected.
This can be especially critical for startups, which often operate in a highly competitive and rapidly changing environment, where success is not guaranteed. By limiting the liability of the founders, incorporating a startup can provide a safety net that allows the owners to take calculated risks without jeopardizing their personal assets. This can give startups a greater degree of flexibility and agility in pursuing new opportunities and adapting to changing market conditions, which can ultimately increase their chances of success.
This applies to all businesses, but no article would be complete without a discussion on tax. As a sole proprietorship or partnership, all of the profits and losses of the business are passed through to the owners and are taxed at their personal tax rates. This can be a disadvantage if the business is profitable, as the owners may end up paying a higher tax rate. When you incorporate your business, it becomes a separate taxpayer. This means that the company pays its own taxes, and the owners are only taxed on the income they receive from the company. This can result in a lower tax rate for the owners and can help them save money on their taxes.
In addition, in the event of an exit (and if the company meets certain criteria), the founders can utilize the lifetime capital gains exemption to shelter a portion of the capital gains from the sale of their shares from tax. As of 2023, the lifetime capital gains exemption amount is $971,190, which means that founders can shelter up to that amount of capital gains over their lifetime.
Finally, incorporating your startup can help you establish a professional image. Like it or not, a company is seen as a more serious and legitimate business entity than a sole proprietorship or partnership. This can help you attract customers, investors, and employees, and can make it easier to build a successful business.
Incorporating your startup is a critical step in establishing a strong legal foundation for your business. Not only does it provide protection for the business and its assets and add significant value to the startup, it helps you attract investment, minimize taxes, and limit your personal liability. By incorporating your business early on, you’ll be setting yourself up for success and ensuring that your business is positioned for growth, profitability, and a successful exit.
Ava Aslani has built a successful practice specializing in tech startups and digital entrepreneurs. She can help ensure you get up and running with a solid legal foundation and set your company up for success!