One of the key considerations when starting a business is determining the legal structure of the business: sole proprietorship, partnership (general or limited), or corporation, among others. Each of these structures comes with its own benefits and drawbacks and, though the structure of a business can be changed later, cost and legal considerations may make this difficult. For this reason, it is important to think carefully and seek out legal advice regarding what structure you want your business to have when starting out. There are other forms of business structure beyond those discussed below, such as co-operatives or trusts, though they are fairly rare or heavily specialized to particular types of businesses.
Perhaps the easiest and most cost-effective structure to set up is the sole proprietorship. Under this structure, you are the self-employed sole owner and manager of the business and, legally speaking, you and your business are essentially considered one entity. The main benefit is that as a sole proprietor you have complete control over the direction and finances of the business and all profits flow to you. Though this high level of autonomy may be quite appealing, the downside is that, should the business incur any losses or face financial troubles, creditors can not only go after the assets of the business but your personal assets as well. Sole proprietorships also have minimal regulatory requirements when starting out and typically need only to comply with certain licensing requirements depending on the nature of the business.
Generally, sole proprietorships are a good choice if securing start-up funding on your own is not an issue, if you don’t foresee a high risk of liability, or if the idea of using any potential initial losses to reduce personal taxable income is appealing. In the long term, however, as businesses grow, they will typically opt for one of the other business structures to better manage the business and the associated liabilities.
A partnership is a business that is created by two or more people pooling resources into the business, and then sharing profits and other responsibilities based on an agreement that is determined between the parties. Similar to sole proprietorships, partners personally own the assets of the business and are considered to be self-employed. Partnerships are also found in two distinct forms: General partnerships and limited liability partnerships. In a general partnership, the partners are jointly liable for the losses and debts of the business, as in sole proprietorships. Limited liability partnerships on the other hand, are generally only available to certain groups of professionals (i.e. lawyers or accountants).
The general advantages and disadvantages of partnerships are similar to sole proprietorships in that they provide a great amount of autonomy and control over the business but ultimately the partners are also personally liable for financial problems incurred by the business. In contrast to sole proprietorships, partnerships make securing initial funding an easier process as resources are pooled from multiple individuals. The division of responsibilities under partnerships can also ease some of the burden of managing the day-to-day operations of the business. Besides the unlimited liability, problems with partnerships generally arise out of personal and legal conflicts between partners regarding the management and finances of a business.
Overall, partnerships are a good choice if you wish to share the management responsibilities and liabilities of the business and if the partners do not foresee a high risk of liability. If liability is an issue, however, then corporations might be a more appropriate choice for you. Furthermore, having a lawyer draft the partnership is highly recommended since partnerships have slightly higher regulatory requirements than sole proprietorships (varies by province) but also so that the rights and responsibilities of the parties involved can be determined and all parties are protected in the case of disagreement between the partners.
Though generally more expensive to initially set-up compared to sole proprietorships or partnerships, incorporation offers key distinct advantages and may be a good course of action not just for new businesses but also for already-operating and steadily growing sole proprietorships and partnerships.
The primary advantage of incorporation is the fact that the corporation is considered a separated legal entity and therefore the business’ liabilities do extend to the personal assets of its owners, managers, and employees. This also allows for the continuous existence and ease of transfer of the corporation if the need should ever arise. Corporations also offer a beneficial tax regime as they can often qualify for lower tax rates than personal income, which is how sole proprietorships and partnerships are generally taxed, along with providing various exemptions and deductions. Furthermore, corporations offer several strategic advantages in that shares of the company can be easily bought and sold to raise capital and different activities of a business can be separately incorporated so that the liabilities of one aspect of a business do not affect the rest.
The advantages provided by incorporation are not without cost, however, as corporations are more heavily regulated and scrutinized by both the Federal and Provincial governments, requiring owners to make regular disclosures in the form of minute books, resolutions, ledgers, etc. Income derived from the corporation in the form of dividends may also be taxed again (on top of the initial tax on the corporate income) and any losses incurred by the company cannot be used to mitigate personal taxable income (as with sole proprietorships and partnerships).
Though incorporation provides many benefits that may be appealing to you, one should think carefully of the nature of the business before going down this path. Due to the complicated nature of corporations, it is highly recommended to seek out legal advice to understand all the potential ramifications of incorporation.
Whether you are looking to set up a sole proprietorship, partnership, or corporation, or another form of business, TSC Law can assist you with all stages of structuring your business, as well as providing legal advice relevant to the particular circumstances of your business.