When you start a new business, your first decision will be the type of business structure that is the most appropriate for you. Sole Proprietorship, Partnership and Incorporation all have their benefits and drawbacks. No one method is best in every case, and consideration must be given as to which method will be most appropriate in your situation. To analyze your options, consider the following criteria: desirability of limited liability; desirability of perpetual existence; number of proposed proprietors; borrowing requirements; cost; and income tax.
1. Sole Proprietorship
Whenever an individual carries on business for the individual’s own account without involving the participation of other individuals (except employees), the individual is operating as a sole proprietor’s personal tax return.
1. Low start-up costs.
2. Greatest freedom from regulation. A sole proprietorship is not required to be registered if the business is carried on under the owner’s name. If the business uses a name other than the owner’s or adds “ and Company” or other word, the Business Names Act requires that the business name be registered before it is used. The registration is then valid for five years and currently cost $80.
1. Unlimited personal risk. All assets of the owner are exposed to creditors of the business.
2. Lack of continuity.
3. More difficult to capital.
A partnership consists of two or more persons carrying on business with a view to profit. The individual partners must each report their share of the partnership’s income (or loss) as their own, whether or not they have taken any of the profits out of the partnership. A partner is not taxed on draws but on his or her share of the partnership’s income.
1. Ease of formation. A Partnership Agreement should be prepared.
2. Low start-up costs.
3. Limited outside regulation. The business name must be registered.
1. Unlimited personal risk. Each of the partners is personally liable for the full amount of the debts of the partnership.
2. Lack of continuity. The death or voluntary retirement of a partner dissolves the partnership. An individual interest in a partnership is transferable only with the consent of the remaining partners.
3. More difficult to raise capital.
4. Responsibility for your partner’s actions. Unless otherwise stipulated in a Partnership Agreement, each partner is authorized to act on behalf of the partnership and bind it legally.
A corporation is unique in that it is a distinct legal entity separate from that of the people who own its shares.
1. Limited personal risk. The greatest advantage of incorporation is the limited liability that it confers on shareholders with respect to debts, obligations and liabilities of the corporation.
2. Ability to raise capital. The ability to issue various classes of shares with preferences as to dividends, redemption or convertibility and to utilize bonds or debentures greatly enhances a corporations ability to obtain funds for expansion or development.
3. Possible tax advantages. Small Canadian controlled private corporations are taxed at approximately half the regular rate on the first $500.000 of active business income in each year. A corporation also has additional tax planning and income splitting arrangements available.
4. Continuous existence & Ownership is transferable. The death or withdrawal of a shareholder does not affect the existence of the corporation, which enjoys perpetual succession.
1. More closely regulated.
2. Most expensive form to organize. A corporation is created by filing Articles of Incorporation with the Ministry of Consumer and Commercial Relations. Presently, the Ministry charges $360 for the filing in Ontario ($200 federally). If the corporation has more than one owner, a shareholder’s agreement should be prepared.
3. More record keeping is necessary.