Hey Guys! Today's post is going to review legal structures that are available for entrepreneurs in Ontario.
I am a lawyer. I have now been doing this for more than ten years.
Over these ten years, I have had the privilege of working with numerous entrepreneurs and their business structures, including sole proprietorships, partnerships, and corporations.
Last year, when we got locked down, I was shocked. Then, I started thinking about how I can contribute to this society without going outside. 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.
It's all good man. Let's do this.
The Big Three
Today's post reviews the three most relevant structures for guys (or girls) who are just getting started in their own business.
With a few caveats for regulated services and industries, there are basically three structures that people use to do business in Canada:
- a sole proprietorship;
- a partnership; and
- a corporation.
Is it absolutely necessary to use one of these three forms? No. Is it somehow illegal if you do not use one of these three forms? No, not necessarily. But, with all due respect, those questions would just be a distraction.
The point is nothing more and nothing less than this: there is a "Big 3" of business structures: the sole proprietorship; the general partnership, and the corporation.
Especially if you are just getting started on your entrepreneurship journey, it really does help to have a clear sense of the basics. (Once there is significant cash-flow and your business team gets bigger, that is when you are going to start customizing one - or more than one - of these basic structures.)
The reality is that a first-time entrepreneur is incredibly unlikely to need to do business through a cooperative, for example. (A cooperative is simply not going to be the right structure for an early-stage business run by a single entrepreneur or a small team. For that reason, I am not going to cover it here.)
Corporation (Provincial or Federal)
At law, a corporation is a separate entity from its owners.
We have blogged three theories about why corporations have a separate legal existence. The bottom line, tho, is that Canadian courts are respectful of the corporate form. They will 'pierce the corporate veil' only in exceptional circumstances. Thus, it is correct to say that a corporation and its owner(s) have separate legal identities.
The corporation's separate identity results in limited liability for the owners. Put very simply, the most the shareholder can lose is whatever he has put into the corporation. Limited liability is a major advantage of the corporate form. It applies to both financial and legal liabilities.
Another key feature of a corporation is the expansive range of activities that a corporation can participate in. Canadian law adopts a liberal approach to corporate acts: a corporation is a legal person. It can enter contracts and own property. It can sue or be sued. It can lend money, borrow money, and buy insurance. (If the founder of a corporation today wants to limit its activities, they can do so in the Articles of Incorporation.)
The corporate structure facilitates multiple owners. It is also relatively easy to transfer ownership by selling shares to another businessperson or back to the corporation. Corporate shares are also significant if you intend to raise money from investors. (Without incorporation, the business will simply not be able to issue shares to potential investors.)
It is also essential to think about the tax consequences of incorporation. In Canada, the simple truth is that corporations' tax rate is lower than the tax rate on individuals. The government also makes various tax reductions available to small businesses only if they are incorporated.
Sole Proprietorship
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. The following goes through three potential advantages with particular attention to our 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.
Partnership
Canadian law recognizes three types of business partnerships. We are focused on the general partnership because it is the most relevant for first-time entrepreneurs.
A general partnership is a business arrangement between two or more individuals who share the business's profits and liabilities.
In a general partnership, 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.
Personal liability applies to both financial and legal liabilities. Suppose you are a partner in a general partnership that incurs debts. In that case, the business' creditors can and will seek to collect from you personally. You could also be brought in to litigation relating to something that happened in the business or even something done by one of your partners.
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 meeting or record-keeping requirements. Also, like with a sole proprietorship, the profits - or losses - of the partnership will flow to the individual partners as business income. For these reasons, it will generally be 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. Specifically, a partnership should have a partnership agreement
Tips for Choosing Your Business’ Structure
We have now reviewed the corporation, the sole proprietorship, and the business partnership.
But, which one is right for you and your business? The right structure is gonna depend on you and your business, and the following is no way legal advice.
Here I want to share a couple tips, let’s call them key considerations, for identifying your best choice.
What Do You Want, Do you Want a Separate Legal Identity?
How important is it for your business to have a separate legal identity from that of the owner or owners? Your answer to this question is going to be important. Your response will probably depend on both the circumstances of the business itself and those of the owner(s).
For example, suppose the business already has significant revenue. In that case, it may well be imperative for the business to establish a separate legal identity. Likewise, imagine the business is operating in an industry that is inherently risky, such as construction. Then it may well be crucial for the business to establish a separate legal identity.
Furthermore, the circumstances of the owners are also important. Suppose that some of the owners are only going to be involved passively, and may eventually want to sell their ownership interest. Then again it probably makes sense to think seriously about establishing a separate legal identity for the business, i.e., through incorporation.
Team of Entrepreneurs or Rolling Solo: Who Owns and Runs Your Business?
Another consideration is whether there is more than one owner of the business. If there is more than own person who is investing in the business, then sole proprietorship is not going to be appropriate. You are instead looking at either a corporation or a partnership. As we noted above, in the case of a partnership businessmen who are serious are going to want to use a partnership agreement. Here I just want to add that a lawyer should be brought into properly draft the 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 in the business, a plan for any eventual dissolution of the partnership, and etcetera. Prior to executing the partnership agreement the partners should have had an opportunity to receive their own, independent legal advice. In this respect, the partnership is going to achieve some but not all of the benefits of the corporation. In particular, it is going to play a role in coordinating the activities and expectations of multiple actors in the business.
For the Love of God, Please Do Not Forget about Tax
You know the old joke. There are only two things that are certain in life: death and taxes.
I am not an accountant (thank G*d). Still, I can definitely tell you from personal and professional experience that you overlook your business's tax consequences at your peril.
Here let me drop a couple of points about the corporation. The simple truth is that, yes, corporate tax rates are lower than individuals. The government also makes various tax reductions available to small businesses only if they are incorporated.
But, there is almost always a flip side: if all of the corporation's income immediately comes out in the form of dividends, then that money is still going to be taxed at the individual rate. So, the basic point is that the business needs cash-flow and a cushion that can be invested back in the business before any tax advantage is really going to kick in. Having made that basic observation, please do remember to get professional tax advice.
Bottom Line
Although the simple answer is not always the best answer, the simple answer is that the most powerful legal structure for Toronto entrepreneurs is incorporation.
A corporation provides limited liability, increased flexibility and attractiveness for raising money, and potential tax advantage as well as the opportunity to build a long-term brand. A few readers have asked for more information about incorporation. I am working on an "Ultimate Guide" (lol that is a joke. Shopify produces an "Ultimate Guide to Incorporation". I am never going to be as "Ultimate" as Shopify. So, my guide on this subject is just going to be called "A Lawyer's Realistic Guide to Incorporation")
It is a bit of work putting the guide together but hey it is all part of a bigger cause, right? So, yeah, the guide is going to be coming out in a few weeks. If you are serious about incorporation, please feel free to grab a copy, which will ultimately be linked below.
The corporation is not the only acceptable structure for you and your business. In Toronto (i.e., in Ontario), you also can do business as a sole proprietorship or as a partnership. Those structures are not going to offer limited liability but they do have their own advantages. For everything there is a place and a time.
Remember guys: it’s all good, man. Stay positive, stay focused on building your business, stay focused on building win-win relationships with those you are close to. If you have specific questions or topics that you would like to see covered in this blog, please do drop us a line.