The decision to start your own business in Canada is an exciting and sometimes stressful process. However, now more than ever, there are endless opportunities to realize your entrepreneurial dreams. Between creating a business plan, funding your project, and finally making the leap to open your own firm, there are many steps that you need to follow and legalities you need to consider.
One of the most important decisions you will make as a new business owner is the legal structure of your operation. Across the wide spectrum of businesses in Canada, every organization will fit into a specific legal structure. The challenge for many is deciding which type of legal structure works best.
Continue reading to learn more about the different legal business structures and find out how to choose the one that is right for you:
This is the simplest, easiest and also riskiest type of business structure in terms of fault or liability. A sole proprietorship is a business that is owned and operated by just one person. For a lot of entrepreneurs who are just starting out, this is the best option for a first-time business. This is also often the preferred business structure for creative services, such as freelance writers, artists, musicians, and others who offer their talents to clients.
The sole proprietorship is very simple in that there is no incorporation required, which cuts down on a lot of complex paperwork. It also means that as the sole owner of the business, 100% of your profits are put towards your personal income, which are then taxed. However, even though the business structure offers simplicity, there are other risks associated with a sole proprietorship. Because you and your business are one and the same, you are 100% liable when it comes to any unexpected costs or problems that may arise. It also means that your profit is considered your personal income as well, meaning that if you have a very good year in the business, this can bump you up to a new tax bracket, and you’ll pay higher personal income tax.
The next step up from operating a business as a sole proprietor is running it with an additional business partner (or multiple business partners). In a typical business partnership, both parties are involved in running the business, both have a share of the operating profits and are financially liable to the business’ creditors.
There is also an option known as a limited partnership. This is akin to having a “silent” partner, in that one of the partners may not necessarily participate in actual day-to-day operations, but merely provide funding or other support. For professionals in either the legal or accounting practices, there is also the “limited liability partnership,” which offers similar protections to incorporation, meaning some partners can be protected against the liabilities of the company.
However, for most partnerships, the liability is equal to that of a sole proprietorship. You and the other partners are 100% financially responsible for any liabilities, which means that you may be responsible to make payments straight from your personal finances if needed. It also means that your personal income is determined by your company’s profit, so again, movement to other tax brackets on your personal income tax is possible.
The next, much bigger leap is to an incorporated business, which leads to a business entity known as a "corporation". This is the traditional big business structure that most people are familiar with, where it is now possible to have shareholders that provide investment in a company, and directors who actually dictate company operations. The laws and regulations surrounding incorporated companies are also much more strict. A typical incorporated company has management, employees, and a much more elaborate financial and operational structure. That said, it is possible to own an incorporated company as an individual.
At the corporate level, the business owner is distinct from the company. As a shareholder, you now have limited liability, and what happens to your company does not automatically affect you personally (unless you are also a Director, in which case some of the Company liabilities may be imputed to you, such as, but not limited to, deductions at source, sales taxes, etc.). You can give yourself a salary, and be taxed on your personal income strictly on that salary, while your company pays its own taxes. This is by far the most tax efficient structure available.
It is important to note that having an incorporated business requires more ongoing legal and accounting work. These additional administrative requirements, although minimal, increase the overall costs of running a business. However, the tax efficiency and the liability protection far outweigh these additional costs.
While there’s no hard and fast rule about the right way to start a business, many owners have gone the more traditional route of starting small and building up. Starting as a sole proprietor and moving to a partnership, and then incorporation, is a logical path to take. It’s also possible, however, to start with any structure, depending on the unique needs and features of your business.
The important thing is making the right decision before you jump into owning a business. You need to know whether to register your business at the provincial or federal level. This is determined by the scope of your activities. Other questions that should be answered before deciding on your business structure include sorting out the shares and voting rights, as well as including provisions to take effect should a partner decide to leave the business. All of these things must be considered ahead of time so that you are not left in a precarious situation in the case of a buyback or other unexpected event.