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Structuring Your New Business
by Mike Pendrith
Frequently I am asked, “What is the best way to structure my new business?”
There are three possible legal structures to any business: a sole proprietorship, a
partnership or an incorporated company. There are pros and cons to each of these
structures.
Sole Proprietorship
A sole proprietorship is a business that is owned and operated by one individual.
Under the law, a proprietorship is not a legal entity, but it does require the necessary
business permits and / or operating licenses.
A proprietorship is regarded as an extension of the individual who owns it. The owner
possesses all of the assets of the business. He/she is also responsible for all of the
debts and liabilities of the business.
Any loans to the proprietorship are treated as personal loans to the individual. For
income tax purposes, the profit or loss of the sole proprietorship is combined with other
earnings of the individual.
Partnership
A partnership is a relationship involving more than one person for the purposes of
owning and operating a business. A partnership can be established without obtaining
government approval. There is no restriction on the number of individuals that may be
involved in a partnership.
A partnership is a legal entity recognized under the law and as such has its own
rights and responsibilities. A partnership can sign contracts, borrow money and obtain
trade credit. Each partner is responsible for the liabilities of the partnership. When
partnerships do not meet their financial obligations, creditors will often first go after the
wealthier partners.
Creditors may require a personal guarantee from each of the partners before granting
credit.
A partnership does not have to file income tax returns or pay income tax. However
the profit or loss from a partnership is combined with the personal income of the partners
for income tax purposes.
It is wise to create a partnership agreement that documents the rights and obligations
of each of the partners. This can eliminate future problems in the event that one of the
partners decides to leave the business.
Incorporated Company
An incorporated company is a separate legal entity. A company can be incorporated
under either provincial or federal law.
The corporation is responsible for its debts. Typically, the owners or shareholders of
the incorporated company are protected from most of the liabilities of the business.
However, when an incorporated company is small and first starting out, creditors and
banks may require personal guarantees from the principal owners before extending
credit.
The corporation must file income tax returns and pay taxes on its income from
operations.
Annual tax returns must be submitted to both the Federal and Provincial
governments.
The legal and government registration fees for incorporation usually run in the $1,000
- $1,200 range.
The legal protection afforded to the owners of an incorporated company can often
outweigh the expense of incorporation.
Which structure is best for me and my business?
There is no right or wrong answer. The structure that best suits your needs will
depend upon several factors.
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Is more than one person involved in the ownership of the business? If so, then consider a partnership or an incorporated company. If only one person is involved in the business, then consider either a proprietorship or an incorporated company.
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What is your level of risk? Are you comfortable with the possibility of creditors coming after your personal assets? If you want to insulate yourself (and your partners) in the event of bankruptcy, it might be best to consider creating an incorporated company.
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Do you want to combine proprietorship or partnership income with other forms of personal income for income tax purposes? If you have little or no other source(s) of income, then combining proprietorship or partnership income can be considered. If you operate an incorporated company, you will have to pay personal income tax on the salary paid to you by the business.
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Can you afford the incorporation fees? As stated, incorporation costs will be in the $1,000 - $1,200 range. Some business owners with limited start up capital see this as an expense that they would like to avoid or at least defer until a future point in time.
- Do you want to have to file annual corporate tax returns with both the Federal and Provincial governments (as with an incorporated company)? There is a cost to do this. You will require an accountant to prepare and submit your returns.
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Before starting your business, you would be wise to consult with both an accountant
and a lawyer to ensure that you fully understand each of these options and their
implications, in order that you can establish the structure that is best suited for both you
and your business.
Mike Pendrith is the CEO of PerformancePoint Corporation. He works as an advisor to owners of small and medium
sized businesses.
Mike writes business plans for start up organizations. He also works with owners of existing
businesses to help them to develop strategies and implement plans to grow their businesses, increase profits and
improve operating efficiencies. For additional information, Mike can be reached at: pendrith@performancepoint.ca
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