There are multiple factors to consider when choosing a business structure that best suits your short and long-term needs. The most common business structures in Ontario are:
- Sole Proprietorship
- Partnership
- Corporations
Each type of business structure has its pros and cons, let’s discuss which one would be ideal for you based on a few key factors.
Starting a Sole Proprietorship
A sole proprietorship is when you start a business, with no partners or other individuals, all on your own. In a sole proprietorship, there is no distinction between you (the business owner) and the business.
Some examples include:
- A freelancer, doing a gig on the side
- An independent consultant
- A professional such as a doctor, lawyer, financial advisor
There are several pros and cons to starting a sole proprietorship, we list some of which below:
- Complexity - Sole Proprietorship is the simplest business structure to have in Ontario.
- There are minimal costs associated with registering your sole proprietorship
- The process is not long or complicated, and many of the steps can be completed on your own
- Liability - Your liability in a sole proprietorship is unlimited because there is no distinction between you and the business.
- You are personally liable for any of the business’s obligations such as loans, business debts, and any potential lawsuits. Your personal assets can be used as collateral to settle the business’s obligations
- For example, your business gets sued or you declare bankruptcy. Now, you are personally liable to pay off these debts incurred by the business. This means that your home or any other personal assets can be used as collateral to repay the business debts
- Taxes - The income you generate from your business gets added to your personal income, and thus you will be taxed based on your personal income percentage.
- You are responsible for filing your personal taxes along with business taxes
- Taxes are paid based on your (the business owner’s) tax bracket. This means that if your business generates a net annual income (after operational expenses) of $60,000, then you will pay personal income taxes on the $60,000
Considering a Partnership
A partnership is similar to a sole proprietorship, however, instead of one individual, two or more individuals must be carrying on a business.
In order to form a valid Partnership, three criteria must be met:
- The individuals must be carrying on a “business” – which is defined in section 1 of the Partnership Act
- The individual’s carrying on a business must do so with a “view to profit”. Meaning if the objective of the business is charitable or social then it is not a “Partnership”
- The individuals must have an agreement to carry on business in common and share profits. This can be a written or oral contract between the parties
Once a Partnership is formed, you and your partners will manage the business together, share profits, and decide how debts and obligations will be distributed.
Depending on the type of partnership you may need to draft and sign a separate legal document, referred to as a Partnership Agreement. A Partnership Agreement is an agreement between the partners, which sets out the terms of the partnership; such as how profits will be shared, who has decision making authority, how losses will be distributed, the length of the partnership, and other relevant issues or characteristics of the partnership.
There are Three Types of Partnership
There are three types of partnerships that you can form in Ontario. All must comply with the criteria set out above in order for the partnership to be valid. However, each has some specific characteristics and/or requirements that set them apart from the other types of partnerships.
Here is a quick summary of each partnership type.
General Partnership
A general partnership is when you and at least one other person form a partnership together. You and your partner(s) will manage the business together, share profits, as well as debts and obligations, which may arise.
- Complexity - General partnerships are not complex and are relatively easy to set up.
- There is no formal requirement for a partnership agreement, which means it is up to the partners to either decide to draft one or have some other agreement
- Liability - The liability of each partner for the partnership debts and obligations is unlimited. Each partner is “jointly and severally” liable for any debts, liabilities, and/or obligations incurred by the partnership or any other partner.
- “Jointly and severally” means that you will be personally liable for any wrongdoings caused by any other partner in the partnership, even if you did not do anything or were aware of it
- For example, let's say you establish a partnership with John and Smith. Imagine if John misappropriated funds from the partnership and now there are creditors after John. Since the liability of each partner is unlimited and each partner is “jointly and severally” liable for the wrongdoings of other partners, it means that the creditors can sue either you, Smith, or John. The creditors can even sue all three of you
- Tax - Each partner is taxed separately and the tax rate is based on that specific partner’s personal income bracket
Limited Partnership
A limited partnership is similar to a general partnership with the exception that you have one or more “general partner(s)” and one or more “limited partner(s)”. The “limited partner” contributes money or property to the partnership but does not operate the partnership or take part in the business
- Complexity - The complexity of the partnership depends on how many general partners and how many limited partners there are in the partnership. The more partners, the more complex the partnership becomes.
- One key difference between a limited partnership and the other two types of partnerships is that a formal partnership agreement must be created
- Liability - The general partner’s liability is unlimited; while the limited partner’s liability is limited to the amount of money or property that the partner has contributed. However, if the limited partner takes part in the control of the business he/she may lose their limited liability
- Tax - Each partner is taxed separately and the tax rate is based on that specific partner’s personal income bracket
Limited Liability Partnership (LLP)
LLP is basically a cross between a general partnership and a limited partnership and it is only available to certain professional groups such as Lawyers and Accountants. This type of Partnership is required by law to add the word “LLP” to the name of the Partnership
- Complexity - The complexity of an LLP depends on the number of partners. The more partners in the partnership, the more complex and complicated it will become
- Similar to a general partnership there is no formal requirement for a partnership agreement, which means that it is up to the individual partners to decide whether they should form an agreement. However, unlike a general partnership, it is highly recommended that a partnership agreement be created
- Liability - Partners are only liable for their own negligence or the negligence of employees under their direct supervision and control, and their liabilities are only limited to the amount contributed to the business
- Tax - Each partner is taxed separately and the tax rate is based on that specific partner’s personal income bracket
Corporations
A corporation is formed when one or more individuals register a business under either the provincial or the federal government. A corporation is a separate legal entity and enjoys almost all the rights as an individual. Unlike a sole proprietorship or a partnership, the corporation will own its own assets and will incur its own debt, separate from you, the creator.
There are many benefits to registering a corporation, but also some disadvantages. Here are some considerations:
- Complexity - This is the most complicated and expensive way of structuring your business. You must first register your business with the government and you must maintain numerous records, documents, and information regarding your corporation
- Liability - One of the main benefits of incorporating your business is limited liability. This means that your own personal liability is limited to your investment in the corporation. This also means that if your corporation is sued, your personal assets cannot be used to settle the dispute, because the corporation is separate from you
- Tax - The corporation pays its own taxes separate from the individuals who either created the corporation or work for it. The corporation is taxed on its earnings based on established rates, which is set out by the government.
- The rate will also depend on whether the corporation was registered federally or provincially
- Unlike sole proprietorship or partnership, corporations generally have fewer limits on the types of expenses they can deduce for tax purposes
Choosing the best method for carrying on a business.
Now that you have a general idea about the different ways of structuring your business, you may be wondering which method is the best option for you. There are many factors that must be concerned in order to decide the best way to set up your business. Some important factors to concern are the following:
- What is legally possible given the type of business you want to set up
- The number of individuals you want to start a business with
- The relationship between yourself and the other individuals you will be starting a business with
- Whether you want to limit your liability as much as possible
- The cost of setting up your business
- Income tax considerations
- Whether you will be hiring any employees
- The flexibility of the structure of your business
- Whether you desire your business to exist, even after your death
This is a non-exhaustive list, which states some of the important factors you must consider. However, it is very helpful to assess your situation and consider these factors in order to determine the best business structure for you
For more information about choosing the best method of carrying on your business please get in touch with us.
