When you're considering the legal structure of your business, in Canada you have four forms of business ownership to choose from, a sole proprietorship, a partnership, a corporation, or a cooperative.
Each of these forms of business ownership has advantages and disadvantages that you will want to weigh before choosing a particular form of business for your new venture. First, let's look at the advantages and disadvantages of sole proprietorships, the most popular form of business ownership.
The Advantages of a Sole Proprietorship
The simplest form of business is the sole proprietorship, a business owned and operated by one individual. You can operate a sole proprietorship under your own name, or under another name you've chosen (as long as you don't add any of the legal designations of other forms of business, such as Ltd. or Inc.)
One of the biggest advantages of a sole proprietorship is that setting up and administering the business is comparatively easy and inexpensive. For instance, in most provinces, if you choose the sole proprietor form of business ownership and operate it under your own name, you don't even have to register your business.
(Note that while the basic procedure for setting up a business is the same, no matter what part of Canada you live in, the details are different in each province and territory. For start-up information for particular provinces, such as business registration procedures for each form of business, see:
- Business Registration in British Columbia
- Business Registration in Alberta
- Business Registration in Ontario
- Business Registration in Quebec
- Business Registration in Nova Scotia
And even if you do have to register your sole proprietorship with your province or territory, it's a lot more inexpensive to register than a corporation. Nor do you have to make annual filings when you run a sole proprietorship (although in some provinces, such as Ontario, you have to renew your sole proprietorship business registration every five years).
Another of the big advantages of the sole proprietorship form of business ownership is the tax simplicity. As a sole proprietor, you declare your business income on your personal income tax form, rather than having to file a separate tax form, (as you would have to do if you chose the corporate form of business ownership).
Too many small business owners, the best advantage of the sole proprietorship is that as a sole proprietor, you own 100% of your business. You’re the one that runs your small business and no one else can tell you what to do or how to do it.
Disadvantages of Sole Proprietorships
What appears to be an advantage at first look can also be a serious disadvantage. When it comes to disadvantages of a sole proprietorship, being the sole owner can be disastrous if things go badly.
If you set up your business as a sole proprietorship, legally your business is considered to be an extension of yourself, meaning that you assume all responsibilities for the business. This means that as a sole proprietor, you are personally responsible for all the debts and liabilities of your business. So if your business fails, any of your assets, including your personal assets, can be seized and used to discharge the liability you’ve incurred.
This personal liability is the biggest disadvantage of choosing to operate as a sole proprietorship. Other disadvantages of sole proprietorships include a lack of tax flexibility, the increased difficulty of raising money and the potential for weak management if the sole owner doesn't have all the skills or knowledge necessary to lead the company well.
The Partnership Form of Business Ownership
If you don't want to go it alone and be the sole owner and operator of your business, you may wish to legally set up your business as a partnership.
You can create a partnership between two people, or among thirty; the law doesn't set a limit on how many partners may be involved.
There are three types of partnership in Canada, but whether you can legally set up any kind of partnership other than a general partnership depends on what province or territory your business will operate in and what kind of business you're in.
The General Partnership
The most common type of partnership is a general partnership. In a general partnership, each partner is jointly and severally liable for the debts of the partnership.
The Limited Partnership
A limited partnership is an arrangement where a person can contribute to a business without being involved in the affairs of the partnership. As a limited partner, your liability to the firm or its creditors is limited to the amount you invest in the firm. To remain a limited partner, you must take no part in the management of the firm or act on behalf of the company, or you become a general partner. (In some provinces, only certain kinds of businesses are allowed to operate as limited partnerships.)
The Limited Liability Partnership
In Canada, a limited liability partnership is usually only available to groups of professionals, such as lawyers, accountants, and doctors. These partnership agreements are governed by specific provincial legislation. For instance, currently, in Ontario, only lawyers, chartered accountants, and certified general accountants may form a Limited Liability Partnership.
Advantages and Disadvantages of a Partnership
A partnership can sign contracts and borrow money in its own right, which eases some of the liability burdens a sole proprietorship would bear.
The main advantage of the partnership, however, lies in the working relationship between the partners rather than in the legal structure of the company. The most successful partnerships are those where the partners have complementary talents and are comfortable sharing decision making. If one partner has skills and talents the other doesn't, a partnership can truly be a match made in heaven.
And partnerships have the same tax simplicity that sole proprietorships have. Partnerships do not have to file separate income tax returns or pay separate income tax, as the financial information from the partnership is combined with the personal income of the partners to determine their overall tax liability. In other words, if you choose the partnership form of business ownership, you'll still file your taxes using the T1 income tax form.
However, in a general partnership, one partner can be held responsible for all debts and obligations incurred in the name of the business by another partner. As a partner, you can also be held responsible for any wrongful act or omission by other partners acting in the ordinary course of the firm's business - which can be a serious disadvantage.
Another disadvantage of a partnership that many people don't think of until it happens is that partnerships can be the messiest, a most acrimonious form of business ownership to dissolve. If you do decide to form a partnership of any type, a partnership agreement is essential. 10 Questions Good Partnership Agreements Need to Answer explains what such an agreement should cover.
Many people are uncomfortable with the sole proprietorship and partnership forms of business ownership because of the amount of personal liability involved. If this describes you, you may wish to consider incorporating your business.
Advantages and Disadvantages of the Corporation
A corporation (or limited company) is a distinct legal entity separate from its owners or shareholders. Therefore, no member of the company can be held personally liable for the debts, obligations or acts of the company. A shareholder is only liable for the unpaid portion of shares owned.
While this limited liability is an advantage, a corporation is the most expensive and difficult form of business ownership to set up and operate, especially as you may want to incorporate your business federally as well as provincially, an entirely separate procedure.
Federal incorporation gives a company the right to operate under its corporate name throughout Canada, while provincial incorporation gives a company the right to operate under its corporate name in a particular province.
How To Incorporate Your Business in Canada outlines the steps to form a corporation.
Corporations are certainly more expensive to administer because they must file annual income tax returns with the Canada Customs and Revenue Agency (CRA), the provincial Ministry of Finance (and possibly other provinces in which the corporation does business).
But depending on the type of business you're starting and your plans for your business, forming a corporation could be your best choice.
The Cooperative Form of Business Ownership
A cooperative is a legally incorporated business owned and controlled by its members. A cooperative is able to enter into contracts under its corporate name. Liability for the individual members of a cooperative is limited to the extent of the value of shares held.
You can only legally structure your business as a cooperative if your business is organized as, and will be operated as, a cooperative according to the Canada Cooperatives Act. For more information on how a cooperative operates and how a cooperative differs from other businesses, see Industry Canada's Incorporation Kit for Cooperatives.
Structure Your Business Even Before You Name It
The legal form of business ownership you choose will affect everything from the administrative costs of setting up and operating your business, through your tax planning. It's a decision you need to make even before you choose a name for your business.
However, bear in mind that choosing a form of business ownership is not a decision that you can't alter when your circumstances change. Many small businesses, for instance, start out as sole proprietorships and then become corporations at a later date. So pick the form of business ownership that's right for your current circumstances, and review your decision as your business grows.