Whether you are a first-time entrepreneur or an experienced business owner pursuing a new venture, deciding to start a business can be overwhelming. While there are several different components, one fundamental consideration is determining what type of business structure to set up.
It is essential to have a solid understanding of the different types of business structures available, along with their benefits and drawbacks, as the business structure plays a crucial role in how the business will operate and grow. Additionally, the type of business structure chosen can significantly impact personal liability, tax consequences, and legal obligations.
Key Considerations for Determining the Best Business Structure
Business owners must make multiple integral decisions every day, and this obligation starts even before the business is up and running. Deciding on a business structure is not a “one size fits all” approach and requires business owners to have a clear vision and goal concerning the company. It is vital to have an understanding of:
- who will be involved and have control over the business;
- who will raise and provide business capital;
- who will receive profits and own business assets; and
- who will be responsible for debts, taxes and liabilities.
Once a business structure has been decided upon, the business owner(s) can take steps to fulfill their responsibilities under the chosen structure, for example, by drafting shareholder and partnership agreements or entering into a commercial lease, if applicable.
Distinct Business Structures in Ontario
Each type of business structure is accompanied by its own unique characteristics, benefits, and obligations. Generally, Ontario businesses fall within one of the four primary categories of business structures:
- Sole Proprietorship,
- Partnership,
- Corporation, or
- Co-operative.
Each type of business structure is strategically determined based on the goals for the business and aligns the business for success as it grows. Therefore, it is essential to consult with an experienced business lawyer who can provide guidance on the options best suited to the needs of the business and owner(s).
Sole Proprietorship
A sole proprietorship is an informal and relatively straightforward business structure that new business owners and small businesses commonly choose. In a sole proprietorship, one individual owns and operates the business; therefore, the owner/operator and business are considered the same entity concerning legal and tax obligations. The proprietor owns the business, makes the decisions, assumes the business’s risks and liabilities, and enjoys the business’s profits and benefits.
Key advantages of a sole proprietorship include an easy setup process with low-cost requirements and fewer administrative responsibilities compared to other business structures. For example, business income is included as income on the proprietor’s personal annual income tax return, so completing a corporate tax return is not required.
A sole proprietorship’s primary disadvantage is personal liability if the company has unpaid debts or is sued by a customer. Sole proprietors are required to raise their own capital to put into the business, and business income is taxed at a personal income rate, which may place business owners in a higher tax bracket.
Partnership
A partnership is an association between two or more “persons,” including real people or other legal entities, such as not-for-profit organizations. Generally, the parties to a partnership enter into an agreement that governs the overall partnership operations and sets out mechanisms for how expenses, revenue, and responsibilities are divided in percentage form. As a best practice, consulting with legal and tax professionals when preparing the agreement is essential.
Partnerships in Ontario may be subject to the Partnerships Act, Limited Partnerships Act, Business Name Act, and common law. Three types of partnerships may be formed, namely:
- A limited liability partnership;
- A limited partnership; and
- A general partnership.
Advantages of a partnership include low start-up costs with easy set-up and dissolution processes. Partnerships also provide clear information regarding each partner’s share in the company for tax purposes. With more parties involved, partnerships also allow for greater access to business capital.
The disadvantages of a partnership are similar to those of a sole proprietorship in that there is no legal distinction between the business and the partners; therefore, one partner may become responsible for the actions and liabilities of another partner. Partnerships also open up the possibility of conflict and disputes between partners when making business decisions.
Corporation
Corporations are formal business arrangements that create a separate legal entity from the business owner(s) and offer significant liability and tax benefits. Incorporation provides for ownership of shares and distinguishes between the shareholders and the company. It is also vital to prepare shareholder agreements that set out mechanisms to deal with disputes within the corporation. Incorporating a business can be done at any time as the business grows, as business owners often choose to create a corporation once the business is generating substantial revenue. Incorporation can also occur at a federal or provincial level. Depending on the level of incorporation, the business may be subject to the Canada Business Corporations Act or Ontario’s Business Corporations Act.
Since a corporation is its own legal entity, its owners benefit from limited, not absolute, liability concerning the debts and liabilities of the corporation. Further, the corporation can continue to operate despite changes or the passing of its officers and shareholders and will only cease to exist once it is formally wound down.
Due to the substantial protections of incorporation, corporations must keep detailed records and submit an annual corporate income tax return. Incorporation also comes with higher start-up costs, no personal tax credits, and significant administrative responsibilities.
Co-operatives
A co-operative describes a group of people who work together to meet a specific common need. It is an incorporation owned by its members who can use the co-operative’s products and services. Generally, co-operatives are community-based businesses that focus on building and sustaining the local economy. Democratic participation is a key difference between a co-operative and a traditional corporation, as each co-operative member is entitled to one vote regardless of their level of investment and ownership of shares amount.
In a co-operative business, members can access competitive discounts when buying in bulk, compared to prices for products and services that a single business may obtain. Co-operatives also allow for individual services and products to be marketed together with other members, and surplus revenue can be considered an expense, as opposed to taxable income, that is distributed among the members.
As is the case when more than one person is responsible for decision-making, co-operatives are not immune to internal conflict between the members, which could cause a breakdown of the co-operative. Co-operatives also require each member to do their fair share of work to ensure the business’s success, which can create problems if one member fails to fulfill their responsibilities.
The Business Lawyers at Willis Business Law Provide Tailored Advice on Business Structures
The experienced business lawyers at Willis Business Law work with companies and entrepreneurs to provide practical and efficient solutions on various business law matters, including guiding clients on the choice of a business structure, developing sound workplace policies, and ensuring workplace health and safety compliance. Our lawyers work closely with clients to understand their goals in order to position their businesses for long-term success.
Located in the heart of Windsor’s financial district, Willis Business Law is proud to represent clients in the public and private sectors throughout Windsor-Essex County and the surrounding regions. To learn more about how we can assist you with your business set-up, call us at 519-945-5470 or contact us online.
