Friday, March 5th, 2021

Business structure for dummies

By Chris Green on Oct 31 2009 • Filed under Chris Green's Legal Basics

One of the more stimulating exercises facing the budding entrepreneur is deciding upon the structure for her new business venture. There are important considerations of cost, liability and brand protection, and tax to be addressed. There are also the needs of family, partners, financial backers, and employees to be considered. 

So, where to begin the task? 

Remember the KISS principle: Keep it Simple, Sheila. There is no need for you to re-invent the wheel, and most attempts to devise unique and novel business structures tend to crash spectacularly. There are really only three recognized forms of business organization available to the fledgling entrepreneur: proprietorship, partnership, and incorporation.

Proprietorship (often referred to as Sole Proprietor) means doing business on your own account using a trade name. It is the simplest and lowest cost solution involving only the registration of the business name. This is often a good choice for a home-based business that provides services and doesn't have to incur significant liabilities such as buying inventory or leasing commercial space or equipment. 

Unfortunately, a proprietorship offers next-to-no protection for the business name and leaves the proprietor fully exposed to liability for all of the debts of the business, if it falters, and taxes, if it thrives.   

A partnership, of course, occurs when two or more individuals go into business together, and, like a proprietorship, can be established informally with nothing more than a handshake and the registration of a business name. However, a formal written partnership agreement is strongly recommended. A partnership suffers the same lukewarm protection of the business name and personal exposure to business debts, with the added horror that business debts incurred by one partner can come back to bite the other partners. 

Partnership can be an inherently unstable form of business organization. The principle of "All for One and One for All" quickly loses its lustre when friction develops over unequal effort or financial contribution or differing visions of how the enterprise should proceed. Remember, too, that you aren't just in business with your partner, but, indirectly, with her spouse as well, who is no doubt offering gratuitous advice from the sidelines. 

The most formal and expensive type of business organization is the limited liability company. When you incorporate such a company you are actually creating a separate legal entity. The corporation becomes an artificial person in its own right, with the ability to own property, conduct business and pay taxes. You can always spot a limited liability company because it will have, as part of its name, one of the following words: limited (Ltd.),  incorporated (Inc.), or corporation (Corp.).  

When a business is conducted by a limited company, the individual owners or shareholders have no direct personal liability for the sins of the business, so your core personal assets are protected from business creditors. 

Once a business has a robust cash flow there are a number of manoeuvres open to the  shareholders of a limited company to reduce or defer tax. For example, by tinkering with the company's fiscal year end or sprinkling dividends out to various family members by utilizing different classes of shares.  

A business corporation, because of its formality, is a better vehicle for shared ownership of a business, particularly where the ownership interests of some participants is small. For example, when employees are being rewarded with a small ownership stake. The articles of a limited company and the Business Corporations Act contain a number of procedures to assist with the governance of the affairs of the company and safeguards of the interests of all of the shareholders. 

Lastly, incorporation offers better brand protection; the corporate name is protected within the province where you are incorporated. If you wish to incorporate federally, across all provinces, it costs more.  

All of these advantages are not without cost. You will pay a minimum of $400 to set up a limited company if you are brave enough to attempt it yourself. However, this is often a false economy. Most do-it-yourselfers miss important steps such as establishing the corporate minute book, issuing and printing shares, or adopting an appropriate set of corporate articles, and universally they miss the opportunity to create  a share structure tailored to their needs. Once these deficiencies are discovered, the usual course of action is to hire a lawyer to fix everything. 

Rather than open yourself up to the potential of stress, complications, and lost work time that comes from making these kinds of mistakes, it is highly recommended that the entrepreneur use the services of a lawyer right from the start. Average fees run from $1,200 to $2,500 for a basic incorporation. Once created, the company will have to prepare separate corporate financial statements and income tax filings, and will additionally have to make an annual filing with the registrar of Companies at a cost of about $300. 

Confused? Well, just remember that there is no wrong way to do business, and no decision you make concerning business structure is encased in cement. Many entrepreneurs begin as a proprietorship and transition into a corporation when the business has grown sufficiently to make it worthwhile. Many professionals use $40,000 of net income as a threshold for recommending the transition.

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