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Getting started is usually the hardest part of any business endeavour. Our clients will often tell us that they have come up with a great new business concept and now “I just have to incorporate a company”. The problem with that statement, particularly with new business owners, is that the incorporation of a company for the purposes of running a business is not always the best option. When considering the appropriate business vehicle for your needs, the best place to start is with the two main considerations in making such a decision: the tax implications of the business vehicle and the amount of personal liability protection offered by the business vehicle.
There are three distinct vehicles that you can choose from in connection with the operation of your business:
1. Sole Proprietorships;
2. Partnerships; and
Each vehicle has its own benefits and disadvantages.
The Sole proprietorship is the simplest and cheapest business vehicle to operate. As the name implies however, it is only available to those operating a business as the sole principal. Some of the benefits of operating as a sole proprietor include:
i. Low start-up costs;
ii. Lower administration costs;
iii. One income tax filing;
iv. No requirement to maintain bank accounts separately and distinctly from your personal bank account;
v. The ability to claim legitimate business expenses directly against one’s income;
vi. Decision making is not complicated; and
vii. No need to determine allocations of profits or draws.
Some of the disadvantages of operating as a sole proprietorship include:
i. Unlimited personal liability; and
ii. Lack of prestige.
Notwithstanding that there are many desirable attributes of a sole proprietorship, the unlimited personal liability that one has as a sole proprietor is a major disadvantage which cannot be overlooked. All assets, whether used personally or for business, are owned personally. Accordingly, if one is sued successfully, all of those assets are at risk of seizure by a creditor. The potential risk could be mitigated however, through an appropriate business insurance policy.
The sole proprietorship is usually best suited to an individual running a small business that does not have many, if any, employees other than the proprietor. However, if the business is in a dangerous industry where adequate insurance cannot be obtained at a reasonable price and the potential liability risk is high, a sole proprietorship would not likely be the best vehicle for such a business.
There are various types of partnerships that can be entered into. There are general partnerships, limited partnerships, and limited liability partnerships. We will only deal with general partnerships in this discussion.
General partnerships are created when two or more individuals or entities enter into a business that is considered to be an adventure in the nature of trade with a view to earning profits. In simpler terms, any endeavour where the common goal of two or more individuals or entities is to engage in an activity for the purpose of earning money will be deemed to be a partnership. General partnerships can be deemed to exist without a written agreement, however, it is extremely wise to enter into a written agreement when engaging in a partnership. Partnership agreements can be very simple or complex depending on the needs of the partners and the type of business being conducted.
Some of the benefits of general partnerships include:
i. Lower administration costs than corporations;
ii. The ability to claim business expenses directly against one’s income;
iii. Start up costs could be relatively inexpensive depending the complexity of the partnership agreement; and
iii. Income and expenses are reported on the personal tax return of each of the partners;
Some of the disadvantages of operating as a sole proprietor include:
i. Unlimited personal liability;
ii. Higher start up costs than a sole proprietorship and in some cases than incorporation;
iii. Decision making could be complex;
iv. Must obtain and maintain separate bank accounts; and
iv. Selling one’s interest may be difficult and require the consent of the other partners.
For two or more individuals embarking on a business endeavour, forming a partnership or incorporating a company are the two options to be considered. While the general partnership does not offer the same liability protection as a corporation does to its shareholders, insurance can often be used to set off or neutralize such a detractor. If the liability threat is neutralized through insurance, there are many benefits to starting your business through a partnership rather than a corporation.
There are various types of corporations that can be entered created. Unlike partnerships, a corporation does not require the involvement of more than one principal; there could be one or more shareholders in a corporation. We will only deal with the most common of corporations in this discussion.
Corporations must be incorporated by filing the requisite forms with the administrative body responsible for granting incorporations in a particular jurisdiction. Once these forms are filed and articles of incorporation are issued a corporation comes into existence. There is a fee for filing articles of incorporation. A corporation is considered a “person” distinct from its shareholders.
Some of the benefits of incorporation include:
i. Most personal liability protection offered by any business vehicle; and
ii. Many customers and suppliers attach more prestige to a corporation.
Some of the disadvantages of operating as a sole proprietor include:
i. Typically associated with the highest start up costs;
ii. Decision making could be complex;
iii. Requires a lot of administrative work;
iv. Selling one’s interest may be difficult and require the consent of the board of directors or the other shareholders;
v. Requires separate bank account; and
vi. Requires a separate tax filing.
A corporation may be the most commonly chosen form of business entity. It offers the best personal liability protection for shareholders and principals. However, the amount of administrative work required to properly maintain a corporation can be intimidating and time consuming to be done properly. The distinction of a corporation as being a legal person unto itself does not allow the shareholders to freely access the corporation’s bank accounts. Tax issues are much more complicated. Corporations are particularly well suited to complicated and large business endeavours that employ many employees, however, they can be just as effective or appropriate for a small business.
The foregoing attempts to address very broad and general information that should be considered in selecting a business vehicle for your business operations. For a detailed discussion and advice specific to your needs, please contact a member of our Business Law team.