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Business Structure: Which One Is Right For You?
Business Structure: Which One Is Right For You?
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There’s no question that starting your own business can be a complicated and nerve-racking venture. One of the most important decisions you’ll have to make in the early stages is deciding what type of business structure best suits your new business. In Ontario, there are three different types of business structures: sole-proprietorships, partnerships, and corporations. Each type of structure has its advantages and disadvantages, and it’ll be up to you to strike the right balance for your business.
Sole Proprietorships
This type of business structure is as it sounds: you are the sole owner and are duly entitled to all the profits generated from its business. Conversely, you are entirely responsible for all its debts, liabilities and obligations. Unlike corporations, you are personally liable for the company, and therefore, a creditor will be able to make both a claim against your personal assets, as well as your business assets, in order to satisfy any outstanding debt that is owed to them. That is the main distinguishing feature between a sole proprietorship and a corporation: under a corporate structure, your personal liability for the business’s debts and obligations are limited to the financial investment that you’ve made in it, whereas under a sole proprietorship, you remain entirely liable for the business’s debts and obligations.
Advantages:
- Relatively easy and inexpensive to register.
- Regulations are few.
- You maintain direct decision-making control over the business affairs.
- Start-up capital requirements are relatively low.
- Tax advantages for under-performing business – for example, you’ll be able to deduct your losses from your personal income, which will likely result in a lower tax bracket for you.
- You collect all the profits generated from the business.
Disadvantages:
- You’re entirely liable for the debts and obligations of the business. This is sometimes referred to as “unlimited liability.” What this means is if your business is in debt, then its creditors can make claims against your personal assets to satisfy the business debt.
- The income generated from the business is taxable at your personal rate. The possible effect of this is, if your business is successful/profitable, then you could find yourself taxed at a higher tax bracket.
- Issues with business continuity – if, for some reason, you become unavailable or incapacitated, then it’ll become increasingly difficult for the business to continue operations because of its total dependence on you.
- Problems raising capital – banks and investors typically don’t like to invest or loan capital to a sole proprietorship because of the close connection between the business and the proprietor.
Partnerships
Put simply, a partnership is a type of non-incorporated business that’s created by two or more individuals for the purpose of carrying on a business. Under this type of business structure, your finances will be combined with those of your business partner(s). As such, you and your partner(s) will share in the business’s profits based on the apportionment provisions of the partnership agreement.
Not all partnerships are created equal, however. In fact, there are three different types of partnership structures in use in Ontario today, each with its own unique features and purposes. The first type is known as a General Partnership, wherein each individual partner is said to be jointly liable for the debts and obligations of the partnership. In other words, your personal liability for the business’s debts and obligations is shared equally with your partner(s). In a Limited Partnership, however, allows you to contribute financially to the business without being directly involved in its operations. In other words, your contribution to the business will be of a financial nature only, as opposed to both financial and managerial. And lastly, in a Limited Liability Partnership, your liability for the business’s debts and obligations is limited to your investment in the partnership. This type of partnership (LLP) is typically available only to professionals, like lawyers, accountants and doctors.
When seeking to establish a partnership, you should ensure that you codify each partner’s rights and obligations in a partnership agreement. It cannot be stressed enough how important a partnership agreement is to the proper functioning of a partnership, seeing as how it codifies the terms of the partnership agreement, which can avoid costly legal disputes in the event of a falling-out. You should seek the assistance of a trained Toronto Business Lawyer to help you draft a partnership agreement.
Advantages:
- Simple to form and inexpensive to start.
- The partnership’s start-up costs as shared equally among the partners.
- Each partner will share equally in the business’s profits and assets, as well as participate equally in the management of the business.
- Possible tax advantage for under-performing business – if the partnership is generating a meager profit, or if it loses money, then you and your partners have the option of including your shares in the partnership as part of your tax returns in order to lessen your overall tax burden.
Disadvantages:
- No separation in legal identity between the partnership and each partner.
- Potential for unlimited liability for each partner – so for example, if the business is in debt, you and your partner’s personal assets can be realized upon by creditors to satisfy the business’s outstanding debt.
- Difficulty in finding a suitable partner.
- Potential for falling-out between partner.
- You are financially liable for the business decisions made by your partner(s) – so for example, if your partner breaches a contract with another party, you may be held jointly liable for any damages resulting from the breach.
Corporations
Probably the most common of the business structure is the company, or corporation. Corporations can be incorporated at both the federal level, as well as the provincial/territorial level. The legal effect of incorporation is to give the company its own legal identity, separate from that of its owners (known as shareholders). Unlike partners in a partnership and the owner in a sole-proprietorship, the shareholders of a corporation will not be liable for the debts, obligations or actions of the corporation. In fact, the roles of owner and manager are purposely separated in the corporate structure, as often times the owners (shareholders) do not participate in the management or operation of the company.
Advantages:
- Liability for the shareholders of the corporation is limited to their investment in the business – in other words, should the corporation incur debts, the company’s shareholders are protected from personal liability for such debts.
- Easily transferable – ownership of the corporation can easily be transferred, either through an asset purchase, or a share purchase. The ease of transferability is facilitated by the independent legal identity of the corporation.
- Infinite existence – the corporation can theoretically stay in existence for ever.
- Separate legal identity from its shareholders (owners).
- Raising capital, whether by way of equity or debt, is easier under a corporate structure than it would be under a sole-proprietorship or a partnership of any kind.
- Tax advantages – there is currently a tax advantage to earning income through a corporation than it is to earn it personally, or through a partnership.
Disadvantages:
- Heavily regulated – corporations are heavily regulated by both the federal government, and provincial governments. Things like ownership requirements, minimum number of officers, and minimum capital requirements are a few examples of regulations on corporations.
- Higher start-up costs – to set up a corporation, you’ll require more start-up capital because of the lengthy process involved initially.
- Maintaining corporate records – there are a number of documents that must be filed annually with the government by the corporation.
- Possibility of conflict between owners (shareholders) and management (directors) – unlike the other two forms of business structures, a corporation separates the ownership from the management.
- Possible proof of residency or citizenship requirements to hold shares in a corporation, or manage a corporation.
Are you in need of a Toronto Business Lawyer to help you structure your new business? We can help! At LawyerSelect.ca, we work with many competent and driven Toronto Business Lawyers, and we’d be happy to find the most suitable candidate for your business law issue. Call us anytime at 416-419-6959, or visit us at LawyerSelect.ca.