One of the first considerations for an entrepreneur before commencing a business is selecting the appropriate type of business vehicle for the endeavour. This article outlines some of the advantages and disadvantages of the main business structures in Ontario: sole proprietorships, general partnerships, limited partnerships, limited liability partnerships and corporations. The most appropriate business vehicle for the individual will, however, always depend on the particular circumstances of the contemplated business.

Sole Proprietorship

The main advantage of a sole proprietorship is the ease with which the business can be commenced and dissolved. The business is simply formed when one individual starts to carry on business, and it ceases to exist when such individual no longer engages in such business. Nothing more formal is required, except that, depending on the business, you may still need to apply for any required governmental permits or licences. A business name need not be registered if the owner is using his or her own name to conduct the business.

Furthermore, by virtue of being a sole proprietor, he or she has complete control over business decisions and is generally not accountable to others, other than by contract and tort exposure. The ease of operating the business as a sole proprietorship also means that there are usually only modest expenses to starting it up.

The key disadvantage of sole proprietorships is that there is no legal separation between the individual owner and the business. Therefore, the owner is fully liable for all the debts and obligations of his or her business, regardless of how carefully he or she segregates it from all other activities. Creditors of the business become creditors of the owner personally, leaving the owner’s personal assets exposed to claims by creditors. Securing proper insurance may help to mitigate some of the risks.

The owner will also need to declare all revenues and expenses of the business when filing his or her own personal tax returns, which can be disadvantageous from a tax perspective if the business is very profitable (on the other hand, business losses could offset the owner’s other income from employment or other investments, which can be tax-efficient).

There is also no continuity of the business if the sole proprietor passes away. The business dies with him or her and cannot be passed on.

General Partnership

Like the sole proprietorship, a partnership is also simple and relatively inexpensive to form and operate. When two or more individuals or corporations conduct business together with a view to profit, they are typically considered to be operating as a partnership.  There are few formalities required, and the partners can have great flexibility in designing the internal managerial structure of the partnership. The capital and resources required to start up the business can be divided among the partners involved. A well-drafted partnership agreement can also provide a useful blueprint for the partners of how to operate the partnership, how business decisions can be made, the respective rights and responsibilities of each partner, how to deal with profit and loss sharing, how to handle the departure of a partner from the business, and can help to limit disputes among the partners.

Similar to sole proprietorships, the partners in a partnership also have the ability to deduct losses from the partnership business against their income from other sources for tax purposes, which can be beneficial from a tax perspective.

Disadvantages of partnerships as compared to sole proprietorships include the compliance with registration requirements under the Business Names Act for partnerships and the obligation to give notice to creditors under the Partnerships Act if a partner retires. A disadvantage that a partnership shares with a sole proprietorship is the unlimited liability, given that there is no separate legal personality of the partnership. In the case of a partnership, this unlimited liability arises jointly, or jointly and severally for all debts of the partnership, even for those debts incurred by the other partner, since each partner can bind the partnership. Liability can, however, be limited by forming a partnership of two or more corporations, or by forming a limited partnership or limited liability partnership as described in the sections that follow.

It should also be noted that a partner may be a creditor or debtor or employee of his or her co-partners, but not of the partnership. In other words, a partner cannot be employed by his or her own firm. Furthermore, any fundamental change to the partnership (e.g., change in nature of the business, expulsion of a partner, variation of default rules) would require unanimous consent of the partners. This disadvantage can be overcome by careful drafting of a partnership agreement.

Limited Partnership

The limited partnership allows for some partners (limited partners) to have limited liability with respect to the limited partnership. The limited partner’s liability is limited to his or her investment in the limited partnership. The disadvantage from the perspective of the limited partner is that this limited liability status comes at a cost – the limited partner cannot have any managerial control of the partnership or in the direction of the business.

There must also be at least one general partner, who has the control and management of the limited partnership but is also liable for all the debts and obligations of the limited partnership. Such liability can be somewhat limited if the partners use a corporation to act as the general partner, but doing so may complicate the business structure and increase the overall costs.

Limited partnerships can also provide certain tax advantages and are relatively simple to form. Other than complying with the Business Names Act, the only additional legal requirement is registering the limited partnership under the Limited Partnerships Act.

Limited Liability Partnership

The limited liability partnership shields a partner from liability for negligent or other wrongful acts of another partner, and it does not curtail the right to be an active partner in the business. It, too, provides certain tax advantages.

Nonetheless, the limited liability partnership is only available to certain regulated professions (e.g., doctors, lawyers), and it requires some effort and compliance with registration formalities.

Corporation

The main advantage of the corporation is that it is a distinct legal entity, separate from its shareholders (i.e., owners), directors, and officers. It can sue and be sued in its own name, it can enter into contracts (even with its own shareholders), it can own property, and it provides for perpetual succession, which means that it can continue to exist notwithstanding any changes to its shareholders or directors. Perhaps most importantly, shareholders are not generally liable for debts or other obligations of the corporation. The corporation alone is liable for its debts and obligations and this liability is limited to the corporation’s own assets (except for a few caveats, such as if the shareholder agreed to pledge its personal assets as collateral to a creditor of the corporation, personally guaranteed a loan given to the corporation, or if the corporation was formed for an improper or illicit purpose). In most cases, the shareholders only stand to lose the investments they made in the corporation.

Another significant advantage of operating your business through a corporation is the potential tax benefits. Not only is the business income that is kept in the corporation subject to the lower corporate tax rate (as compared to the individual tax rate), if the corporation’s share structure is organized properly, there could also be income-splitting opportunities with lower-income spouses and adult children. The shareholders may also be able to take advantage of the lifetime capital gains exemption (around $800,000) when they dispose of their qualifying small business shares of the corporation. Consulting with a corporate accountant is always highly recommended to determine if and how one could benefit from these tax advantages provided by a corporation.

There are, however, also some key disadvantages that should be considered before choosing to run your business by way of a corporation. For example, the incorporation process can be time-consuming, complex and costly. It involves making certain required government filings,  conducting name searches to ensure the proposed corporate or trade name can be used and preparing many corporate documents to comply with corporate laws.

In addition to the work involved with incorporating, the maintenance of the corporation, too, is more demanding than in the case of the other business vehicles. The corporation’s directors are required to hold meetings, elect officers, and provide shareholders with information. The shareholders must also hold at least an annual meeting to elect the directors, and deal with other formal corporate matters. These requirements, in the case of one-person and closely held corporations, have been greatly simplified by legislation,  but still require the preparation of corporate documentation that must be maintained and recorded in the corporation’s minute book, at least annually. An annual return and corporate tax return must also be filed by the corporation each year.

The creation, maintenance and dissolution/winding up of a corporation are all typically more costly than with other business vehicles, especially when you account for professional fees (e.g., legal and accounting).

Given all the above considerations when contemplating the right business structure, it is prudent that entrepreneurs involve an experienced business lawyer and accountant in the process.

If you require assistance in corporate law, please feel free to contact Stephen Sforza at 905-668-4486 or Stephen@durhamlawyer.ca.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”