Sole Prop v. Partnership v. Corp
When deciding to embark on a new business, attention should be paid to how you would like the business to be structured. There are various ways that a business venture can be structured, but I will only be discussing the three most common in this post: sole proprietorship, partnership and corporation.
A sole proprietorship is the least complicated of the three and occurs automatically when an individual starts a business without making efforts to initiate the formation requirements of another structure. While sole proprietorships may be simple, they may still require the following formal steps:
- Registration of the name of the sole proprietorship;
- Obtaining a business license; and
- Paying income taxes in accordance with the federal Income Tax Act.
At law, a sole proprietor and the sole proprietorship are one and the same, for better or worse. Without the protections enjoyed by its more formally structured business counterparts discussed below, sole proprietorships expose their sole proprietor to a host of liabilities including:
- Personal obligation to fulfill contractual responsibilities;
- Exposure of personal assets to court ordered seizure or sale; and
- Personal liability and vicarious liability (liability for the actions of another) for wrongs committed in relation to the business by the sole proprietor and his employees.
The year-end losses or gains of the sole proprietorship are included in the sole proprietor’s income. Depending on your tax planning strategy this can either be a benefit or disadvantage.
A partnership is generally defined as any business venture entered into by more than one person pursuant to making a profit. Even if that is not the intention, it may be deemed to be so by a court if the nature of the business and the conduct of the unsuspecting partners fits the definition. n in-depth analysis of each is beyond the scope of this post described in a general sense below.
|General||This is the base level of a partnership and has the definition mentioned above.||– Each partner can share in the profits of the partnership
– The losses can be applied against each partner’s personal income
|– Each partner is liable for the acts committed by other partners and employees
– Each partner is liable for the losses and obligations of the partnership
– Personal assets of each partner are exposed to seizure or sale
|Limited||A mix between a partnership and corporation. It is a partnership between a general partner (usually a corporation) that handles the day-to-day operations and limited partners that contribute financially but not to management of the partnership||– Liability is limited to proportion of contribution of each limited partner
– The losses can be applied against each partner’s personal income
|– May require the drafting of a complex limited partnership agreement
– Limited partners have no management control
– Participating in management as a limited partner may deem you a general partner and expose you to the associated liability
– General partners have no limited liability unless they incorporate
|Limited Liability||Common with lawyers and accountants, this structure is single-tiered as opposed to limited partnerships and offers more control and potentially less liability||– Insulates each partner from liability for the acts of other partners and the debts of the partnership
– Partners can take an active management role in the partnership
– Same tax benefits as the other partnerships
|– Liable for the acts of other partners/employees if they were under your supervision (AB/ON) or you had direct knowledge and didn’t prevent it (BC)
– Liable for obligations that existed in the business structure immediately preceding the formation of the LLP
– BC specific director-like liability
– The directors of a corporate LLP partner are jointly and severally liable
This is the most common business structure, largely because of the liability protections it offers. At law, a corporation exists as its own entity, in that it is legally recognized as separate and distinct from its directors and officers and can sue and be sued. While “corporation” and “company” have differing definitions, the nuances of them are beyond the scope of this post, as such they will be used interchangeably.
Corporations can be either public private, with the former having much more regulatory responsibilities than the latter. However, some of those responsibilities that a public company has can be placed upon a private company if they exceed a certain number of shareholders (50 in most jurisdictions). Our discussion will focus on private, closely held companies (low number of shareholders).
- Immortality – a corporation subsists even if all its management and shareholders change, whereas a partnership can automatically dissolve such as when there ceases to be more than one partner
- Limited Liability – with respect to debts, liability of a shareholder is usually limited to the consideration each paid for their shares. However, some lenders may want personal guarantees from company insiders. When it comes to litigation, unless fraud or select other wrongful acts can be proven against a director or officer, the company will be liable for all wrongdoings associated with it. However, keep in mind that various regulatory bodies explicitly hold directors and officers accountable for certain acts and omissions
- Raising Capital – a corporation is often the preferred vehicle for investors
- Shareholders Rights – there are various legislated rights and remedies to which a shareholder can turn when they feel they are in an oppressive or unfair situation. Also, through the accumulation of voting shares, a shareholder can exert a considerable amount of influence over a company without having a managerial role in it
- Tax Advantages – The small business deduction, income splitting and dividend issuances are a few of the ways that a corporation can be tax advantageous.
Incorporating can be quite costly to initiate and maintain and as such a costbenefit analysis should be engaged before jumping into incorporation. Transitions between the various structures as finances and other circumstances dictate may be the best course of action.
The above should give you a general idea of what each structure has to offer and based on your circumstances one may make more sense than another. It is best to engage professional guidance before you begin so that time and money isn’t wasted correcting unnecessary mistakes. Lawyers and accountants are great resources when embarking on a business.
Contact us to schedule a free consultation to get your new business idea of the ground in the best way possible.