As a professional accountant we often asked by our clients about the legal structure of their business. If you research in the internet, you may find a lot of information about various legal business structure in Canada.
Sole proprietorship, Partnership, or corporation? These are all ways that the Canada Revenue Agency can understand what sort of business you are so they can tax you accordingly; however, your lawyer may explain more about how it would be helpful to defer your personal liabilities.
These groups weren’t that expressive before you wanted to start your own business, but now you’re scratching your head thinking about what they mean!
WHAT IS A SOLE PROPRIETORSHIP?
A sole proprietorship is when someone owns and runs a business by themselves. That business is unincorporated. If you decide to create a Partnership instead, even by yourself & your spouse, you no longer run a sole proprietorship.
This structure is the simplest and the easiest to understand. In order to form a sole proprietorship, you don’t need to take any formal action. If you remain the only owner, you are a sole proprietor as long as you are selling your products or services. For example, a freelancer writer who works alone is a sole proprietor.
When it comes to taxes, there is no differentiation between you and your business, so you are taxed as one. You just use an additional Form T2125.
PROS AND CONS OF SOLE PROPRIETORSHIPS
If you’ve decided to take on this endeavor by yourself, a sole proprietorship is probably the way to go. The advantage? Complete control.
Unlike a Corporation, there aren’t any complicated legal agreements involved that determine ownership. If you’re a sole proprietor, you can run the business however you want.
|THE PROS||THE CONS|
|Complete control and flexibility to run the business as you see fit||Personally liable for all business debts, you’re all by yourself|
|Unlimited liability means creditors are more likely to extend credit if needed||Banks are reluctant to give loans due to higher turnover rates and usually smaller assets|
|You receive all business profits||Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough|
|Smaller amounts of capital make for easier organization||Since the business relies on one person only, it is harder to raise capital on a long-term basis|
WHAT IS A CORPORATION?
Corporation has a lot of features that make them attractive to business owners, start up founders, and investors. Here are a few of the most notable:
Limited liability. If something bad happens to the business, it’s seen as a completely separate entity from its owners and founders. This can protect business owners so they are not liable if things go wrong.
Easier to raise capital. Investors like corps because of the stock options. If the company makes a profit, investors can make a lot more money than if they fund partnership, or sole proprietorship.
Stock options. Corps are attractive to employees because of stock options. These options can help lure in top notch employees, especially when the business is first starting out and there aren’t a ton of funds for giant salaries.
Can exist forever. Maybe not forever, but if a company founder dies or if ownership is transferred, the company can continue on without much fuss.
Owners are separate from legal liability so they’re not entirely responsible when faced with legal issues or debt. In general, it’s nice to have the business as a separate entity, so that owners are completely separate. Owners also have the ability to sell stock, which raises the likelihood of acquiring financial capital. A corporation has a well-established structure with clearly defined roles, accountabilities and agendas. Plus, employees have the option to buy stock at a fixed-in price, and receive stock benefits.
Corporations have different requirements than other business entities. You have to fill out more paperwork. In fact, you’re required to hold formal shareholder meetings and take notes on them. You need to spend more time dealing with taxes and nitty-gritty details than for other business entities. The corporate tax forms can be so difficult to fill out that you may need to get a business accountant, though this is a good idea no matter what kind of business you have.
PROS AND CONS OF CORPORATIONS
A corporation is a business entity that is legally separate from its owners. It has the right to enter into contracts, take legal action against others, give and receive loans, own assets, hire workers and pay taxes.
One of the most significant things about a corporation is its limited liability. That is, shareholders have the right to participate in the profits through stocks and paid dividends, but are not held personally accountable for the company’s debts or legal issues that may arise.
Remember that famous trial where the woman successfully sued McDonald’s for serving their coffee at too high a temperature? Good thing McDonald’s was incorporated!
|THE PROS||THE CONS|
|Owners are separate from legal liability so they’re not entirely responsible when faced with legal issues or debt.||The process is time consuming and expensive, lots of paperwork.|
|Ability to sell stock, which raises the likelihood of acquiring financial capital.||Tons of regulations, which make for very little flexibility.|
|Well established structure with clearly defined roles, accountabilities and agendas.||Possibility of double taxation (where both the corporation’s profits and stockholder’s paid dividends are taxed).|
|Employees have the option to buy stock at a fixed-in price, and receive stock benefits.|
WHAT ABOUT PARTNERSHIPS?
In this context, a partnership is a business union in which two or more individuals manage and maintain their business. Unlike a corporation, a partnership requires no incorporation paperwork with the Federal or Provincial government. Therefore, the three types of partnerships – general, limited or limited liability – are somewhat informal structures.
In a General Partnership, all owners (or general partners (GPs) are equally responsible for the debts of the business, each assuming unlimited liability.
|THE PROS||THE CONS|
|Flow-through income taxation for all partners||Each owner is equally responsible for debt and loss|
|Less expensive and less paperwork than incorporating||Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough|
|Partners can pool resources and share the financial obligation rather than facing it alone||Liable for debts and actions of your partner|
|No rigid, obligatory corporate structure||Limited capacity to raise money and attract investors|
In a Limited Partnership, owners can take on the role of a limited partner (LP) who reports to a GP (there can be more than one) and therefore have less responsibility in the event of company debt or accountability. The GPs have managing power, but also take on all of the liability for partnership duties.
|THE PROS||THE CONS|
|LPs have no liability and still make a profit||LPs have no managerial power|
|GPs have total managerial power||GPs have total liability|
|Flow-through income taxation for all partners||More filing formalities than a general partnership|
|Less expensive than incorporating||LPs can lose all of their limited liability if they take on any management roles|
|Flow-through income taxation for all partners||Available only for specific occupations|
|Has the flexibility to choose what kind of management structure it wants because everyone can participate in management roles||Partners are personally responsible for their own or any of their employees’ negligence regarding creditors, proprietors, etc.|
|Less expensive and less paperwork than incorporating or filing to become an LLC|