Hey Guys! Today's post is going to cover the best alternatives to Incorporation. We are going to dive into this topic from the perspective of an entrepreneur in Ontario.
I am a lawyer. I have been doing this for more than ten years now.
Over these ten years, I have had the privilege of working with numerous entrepreneurs and their businesses. (Working with people passionate about their business is probably one of the best parts of being a lawyer.)
Last year, when we got locked down, I was shocked. Then, I started thinking about how I can contribute even if just a little bit while this society is still 'locked down.' One idea was to create this blog as a source of credible, reliable information. In particular, this first set of blog posts aims at being a resource for guys (and girls) who may be first-time entrepreneurs.
Incorporation is a powerful legal structure that works well for some but not all entrepreneurs. It has both legal and business advantages. But, starting and maintaining a corporation may not be the best choice for you and your specific circumstances.
Remember: It's all good, man. Let's dig into some details.
Sneak Peak: Big 3 but no LLC
Our previous posts reviewed the three main structures that entrepreneurs in Toronto use. These "big 3" business structures are: the sole proprietorship, the business partnership, the corporation.
Now, Incorporation is a powerful legal structure. It has both legal and business advantages: think limited liability and the opportunity to create a brand. The corporation is going to work well for many entrepreneurs. Still, there are various reasons why you may want to avoid running your business through a corporation. For instance, the reality is that incorporating your business will mean more paper work, more regulatory responsibilities, and increased costs.
The corporation is not the right fit for every business, and no one said it has to be. (I do get asked about alternatives to incorporation, and the previous blog post also touched on this topic.) So, today I want to share some additional thoughts. Of course, this is not legal advice.
Can’t I Just use an LLC?
In the US, there is a business structure called the LLC. The LLC is a company, but it is not a corporation.
The LLC is often used when a business is first getting started. Our point is not to go into detail about the LLC. Rather, I want to be clear up-front: In Ontario there is no business structure that is strictly equivalent to the LLC.
Even without access to the LLC, tho, there are several options to consider for conducting business. This post runs through three structures that may be relevant and worth considering, i.e.:
- Sole proprietorship
- Partnership
- Contractual joint venture
You are probably going to find that a partnership agreement works best in most cases. But, of course, it always depends on the specific circumstances of the entrepreneurs and the relevant facts at hand.
Sole Proprietorship
If you just want to make your business a little bit more official. Then sole proprietorship can be a great solution.
A sole proprietorship is a business owned and operated by a single individual.
A sole proprietorship can do business under the owner’s name or under a trade name that the owner has chosen (subject to certain limitations.)
The rules for a sole proprietorship will vary slightly depending on the province or provinces in which you intend to carry out business. (Unlike with a corporation, there is no option to register a sole proprietorship with the federal government). The next paragraphs go through three potential advantages of the sole proprietorship. They are based on our specific situation in Ontario.
One of the most significant advantages of a sole proprietorship is that setting up and administering the business is comparatively easy. In Ontario, for example, you simply fill-in an online form and pay a de minimus registration fee. (You will probably also want to register for HST.)
It is also going to be less expensive to operate a sole proprietorship, as compared to, for example, a corporation. For instance, in 2021, the basic fee to incorporate in Ontario is $360. You will need will also need to have a name search report that costs approximately $20. Moreover, the record-keeping and meeting requirements associated with running a corporation will create costs.
Another key feature is that the sole proprietorship itself does not pay income tax. Instead, As a sole proprietor, you declare your business income on your personal income tax form.
The flip side of these advantages is that the sole proprietorship does not enjoy a separate legal identity, which means personal liability.
Furthermore, if your business involves more than one owner, then the sole proprietorship will be an unlikely choice. After all, by definition, a sole proprietorship can only be owned by a single individual.
Partnership
You may know that Canadian law recognizes three types of business partnerships. We are focusing on the general partnership because it is the most common type.
A general partnership is a business arrangement between two or more persons who share a business in common.
In general, each partner is fully, personally liable for the debts, contractual obligations, and torts resulting from the partnership's operation, just as in a sole proprietorship. This applies to both financial and legal liabilities.
As in the case of a sole proprietorship, the natural persons who own the partnership and the partnership itself are not legally separate entities. Because the partnership is not a separate entity, you will not have statutory requirements for meetings or record-keeping. Like with a sole proprietorship, the profits - or losses - of the partnership will flow to the individual partners as business income.
In light of the above factors, it is generally less expensive to administer a partnership than a corporation.
As you can see, a partnership has some of the same characteristics of a sole proprietorship. But, because it is inherently going to involve more than one person, there is added complexity.
Let's highlight one significant and foundational way in which the partnership differs from a sole proprietorship.
A properly run partnership should have a partnership agreement. A partnership agreement will cover a wide range of issues, such as the investment that each partner is making in the business, each partner's role, an agreed upon plan for dissolution of the partnership, and etcetera.
Let’s make a brief comparison to the LLC structure that is only available in the United States. One reason why the LLC has become so popular is that it provides clarity of expectations and roles for those involved. A properly drafted partnership agreement can provide some of these same benefits.
Joint Venture
A joint venture is an alliance between two or more persons who all agree to contribute to a shared 'venture,' i.e., a commercial enterprise.
From a legal perspective, a joint venture is not the same 'animal' as a partnership. Let's briefly review two important aspects of a joint venture.
First, a joint venture is fundamentally a contractual relationship. Second, a joint venture is a partnership-like relationship that is created for a single project.
First, a joint venture is fundamentally a contractual relationship because it can only be created through the parties' agreement on due consideration. In contrast, a partnership can come into existence even if any alleged agreement between the parties would not be valid from the perspective of contract law. Instead, in the case of a partnership, a court will ask whether there was a sharing of profits and losses, joint administration and control of the business, capital investment by each partner, and common ownership of property. The court will also examine the intent of the parties. (Nevertheless, it is definitely best practice to use and negotiate a partnership agreement.)
Second, the parties to a joint venture agreement, i.e., the 'venturers,' come together for a particular project. The scope and terms of the project will be set out in their joint venture agreement.
A joint venture is like a partnership but it has a narrower scope. Think about it this way: the members of a partnership have joined together to run "a business in common". In contrast, the joint venture's narrower scope means that the joint venture's participants do not run "a business in common." (The joint venturers have merely *contributed* to a commercial enterprise in which they all have certain interests.)
The narrower scope of the joint venture has a range of consequences. For example, each party retains ownership of its property even if the property is being used in the joint venture's enterprise. In other words, the property is not being put into the joint venture but only used by the joint venture.
Finally, for today, the skillful use of joint ventures can have significant commercial advantages. But, it is important to be aware that a joint venture creates fiduciary duties between the parties.
Bottom Line
There is an old -- and not especially funny - joke that lawyers love to say ‘it depends.' In this case tho it really does depend. The best vehicle for taking your business to the next level is going to depend on your own personal circumstances and the facts of your business.
But, as a general rule of thumb, if you have limited cash flow and you are the 100% owner of your business. There is nothing wrong with doing business through a sole proprietorship.
On the other hand, it may be that there is more than one owner of the business. In that case, a partnership will be the natural starting point for thinking about how best to structure the business. It may be appropriate to skip the partnership agreement in certain circumstances and instead enter into a joint venture.