Tag Archives: Business development

When To Incorporate

Many people make a big mistake by incorporating at the wrong time. One of my friends made this mistake and he was a Chartered Accountant. He was involved in a real estate development scheme. He incorporated the whole scheme prematurely. Their plans showed the development as becoming profitable at a particular date and he set up the incorporation a few months ahead. The rental market changed and they lost a lot of money for several months, or possibly two or three years.

Because they were incorporated they could not carry the business losses back to their personal tax returns so they had to pay it and could not take deductions for it. This was in Canada. The equivalent in the US would be changing from an S corporation or an LLC to a C corporation.

Before income tax became such a major drag on businesses it was only necessary to incorporate when many or most of the investors did not take an active part in running the business. Now income tax is a major factor, usually much more important than the operational point mentioned above.

It is always difficult to determine when a business is going to become profitable. Unless most of the investors have experience in the business they are guessing. There are also factors that come out of the blue to bite you in the behind. Once a long time ago I was working in a small steel fabrication business. We were churning out estimates for small metal-clad buildings for potential buyers. All of them expected the Canadian government to remove the sales tax on building materials at the next budget. The budget came and the tax stayed. All of a sudden we were not producing any estimates and I was unemployed.

In conclusion you should not set up a corporation or go from an S corporation to a C corporation until the business is actually making money and there are good reasons to expect it to continue to do so. You can never be completely certain but this will often save you from big disasters.