Business Structure: Should I incorporate?

After choosing a name, the next step in starting a business is the decision of what type of business structure to use. Many small business owners assume that incorporation is the most advantageous structure without fully understanding why it is advantageous or whether it is necessary.  Below is an overview of the advantages and disadvantages of Sole Proprietorships, Partnerships, and Corporations; the three most common business structures in British Columbia:

Sole Proprietorship 

A sole proprietorship is the least expensive and easiest form of business to start.  As a sole proprietor, the business owner is said to be self-employed and is responsible for all duties related to running the business.  The sole proprietor will secure capital, establish and operate the business, and personally assume all risk and liability associated with the business.

The major advantage of the sole proprietorship is freedom and ease of startup.  To open your business as a sole proprietor, you only have to register your business name and you can open your doors.  You are not required to file annual reports with the government or maintain extensive records.

The major disadvantage is personal liability.  As a sole proprietor, you and your business are the same person for legal and tax purposes.  This means that any debt or obligation owed by the business is a personal debt or obligation owed by you, the sole proprietor.  As a result, anyone owed money by the business can go after your personal assets (house, car, personal savings) to be repaid.

Other advantages:

  • low startup costs and low maintenance costs
  • owner is the decision maker
  • all the profits go directly to the owner
  • possible tax advantages (consult with an accountant)

Other disadvantages:

  • no continuity of the business (if the owner leaves, business ceases to exist)
  • harder to raise capital
  • your business name is not protected

Conclusions: A sole proprietorship is quick and easy to get started but does not offer the flexibility or potential for long-term growth.  It is a good choice for industries with low-risk of liability that offer services to individuals and do not hire employees, rent office space, or enter into contracts with suppliers and customers.  A sole proprietorship can always be incorporated at a later date if the business continues to grow.

Partnerships

A general partnership is when two or more individuals combine resources with the intention of making a profit.  Like a sole proprietorship, it is relatively easy to set up and there are no filing requirements.  The general partners share in the management of the business and also assume personal responsibility of all the debts and obligations of the business.  With a general partnership, a partner will be liable for the entire value of any liability the business incurs, not just the portion allocated to his or her percentage of ownership.

A limited partnership limits liability for certain partners but requires compliance with filing requirements of the Partnership Act.  A limited partner will only be liable for the debts and obligations of the general partners to the extent of his or her ownership in the business.  In this structure, at least one partner must be a general partner with no limits on liability.  A partnership agreement will be necessary to define the ownership interests of general and limited partners.  A partner may be a general partner and a limited partner at the same time.

A limited liability partnership allows the partners to limit individual liability while still running the business as a partnership. In a limited liability partnership, each partner is liable only for his or her own liabilities, not those of the other partners.  A partner is only liable for the acts of another partner if there is negligence or wrongdoing.  Like a corporation, it requires registration with the BC registrar of companies and annual reports.  Unlike a corporation, the limited liability partnership is not subject to the management requirements that a company must follow.

Advantages of partnerships:

  • can be easy to form with low start up costs (general partnership)
  • more investment capital available compared to a sole proprietorship
  • limited regulation and reporting duties
  • broad management base
  • costs and profits are shared

Disadvantages:

  • unlimited liability (with a general partnership)
  • divided authority for decision making
  • difficult to raise additional capital
  • partners can legal bind each other without approval
  • no continuous existence of the business
  • no name protection
  • potential for conflict between partners is high
  • potentially high start-up costs if all partners seek independent legal advice in negotiation and drafting partnership agreements

Conclusions: A general partnership can be a simple but risky business venture if there is no written agreement outlining the terms of the partnership.  However, a partnership agreement is a private agreement that can be tailored to fit individual needs without the extensive record keeping and reporting requirements of a corporation.  Individuals considering this business structure should seek legal advice to protect individual interests and understand the liability he or she may be exposed to by joining a partnership.

Corporations

When a business is incorporated, it becomes a “legal person” and acquires the powers of an individual that are separate and distinct from those of the individual shareholders. The corporation can enter into contracts, borrow money, sue and be sued, and pay taxes.  Ownership of the corporation is in the hands of shareholders, who appoint directors and officers to run the day-to-day operations of the company.

The major advantage of a corporation is ‘limited liability’.  Because a corporation is it’s own “legal person”, the corporation, not the individual shareholders, assumes liability for the acts of the business.  This means that generally shareholders will not be personally liable for debts, obligations or acts of the corporation.  However, there are certain circumstances when shareholders may be found personally liable for the actions of the company.

Other advantages:

  • shares are easily transferrable so the existence of the company does not depend on certain members maintaining ownership
  • small business tax rates may be lower than individual rates.
  • easier to raise capital by selling more shares or share options
  • there are clear rules for the roles of the people who control and operate the company
  • a corporation can own (be a shareholder) of other corporations which further limits and protects individual liability
  • when a business is incorporated, the name is protected from use by any other business

Disadvantages:

  • a corporation is required to maintain detailed records and report annually to the government
  • depending on how the shareholders get paid, it could result in getting taxed twice (consult an accountant for tax implications)
  • it is more complicated to take money out of the corporation to pay yourself, and payouts have tax consequences
  • the most expensive form of business to operate
  • in some cases, individual shareholders, directors, and officers of a company can be found liable for the acts of the company

Conclusions: If set up properly, a corporation can be a good tool to allow for change and growth as your company develops.  This business structure is appropriate for industries that have a higher exposure to liability, need outside money to grow, or hire employees and contractors to run part of the company.  There is a certain level of government regulation but individual liability is reduced to a minimum.

For more information and legal advice about selecting a business structure, please visit www.selkirklaw.ca

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