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Start-up businesses and small businesses should seek professional advice when determining the best way to operate their business. The three general ways to structure your business are as a corporation, as a partnership or as a sole proprietorship. Each structure has its own advantages and disadvantages. Below I have set out a brief primer on these structures.

Corporation

A corporation is a distinct legal entity from its shareholders. Liabilities of the corporation are generally limited to the assets of the business (and not the personal assets of the shareholders). This structure is also very useful for tax planning. In setting up a corporation, one of the most important considerations is the share structure. Upon incorporation, the types of shares (i.e. common, preferred, special) and their characteristics are set out in the Articles of Incorporation. These characteristics may include:

  • voting rights
  • dividend rights
  • a shareholder's rights to redeem the shares
  • the corporation's right to buy back the shares
  • the right to convert the shares into shares of another class
  • any restrictions on ownership of the shares
  • the ability for the corporation to issue the shares in classes or series

It is important to plan your share structure from the beginning - while it can be changed down the road, such changes will require further costs in legal and accounting work.

If you are considering setting up a corporation with other people, another important consideration is a shareholders agreement. This agreement sets out the rights and responsibilities of all parties and how decision making is to take place. In particular, it clearly and concisely details what is to happen when shareholders disagree on how the business should be run or when a shareholder dies, divorces, goes bankrupt or suffers a disability. In each of those situations, it is preferable to have the rules in place before the situation arises rather than having to deal with other parties once the relationship has begun to sour. It also avoids misunderstandings between the parties from the beginning of the relationship.

Partnership

Unlike a corporation, a partnership is not a distinct legal entity. A partnership arises when a business is carried on in common with other people with a view to profit. The word “arise” is an important one – a partnership may exist despite the partners never having had any formal agreement that the relationship was to be a partnership.

A valid partnership does not depend on the creation of a new business – if another person is “brought into” a business, a partnership may arise. It is also not necessary to show that the partners carried on a business for a long period of time. Sometimes a partnership is a desirable structure for start-up business as it permits the individual partners to deduct losses of the partnership from income from other sources. However, unlike a corporation, the partners are personally liable for the liabilities of the partnership.

One of the most important things to be aware of is the Ontario Partnerships Act. This law creates many rules that apply to partnerships, some of which may be excluded by a partnership contract, such as:

  • all the partners are entitled to share equally in the capital and profits of the business and must contribute equally towards the losses, whether of capital or otherwise, sustained by the partnership
  • the partnership is dissolved by the death or insolvency of a partner

If you are operating in a partnership or are in a relationship that you are uncertain of, you should speak with a lawyer concerning the potential consequences of this relationship.

Sole Proprietorship

This is a form of carrying on business where the law does not distinguish between the single owner and his/her business. The assets and liabilities of the business are treated like the personal assets and liabilities of the owner. The sole proprietorship ends when the proprietor dies. While many businesses start as sole proprietorships, the biggest concern faced by sole proprietors is that their personal assets can be sought to satisfy their business liabilities. The benefit of sole proprietorships is often seen in start-up companies where the sole proprietor has other income. As start-up companies typically experience a loss in their first year of business, these losses may be used to offset income from the other source and thereby reduce taxes payable.

As a start-up business or small business owner, you should speak with a lawyer and an accountant concerning the best way to structure your affairs. This will involve a consideration of what the tax benefits and limitations are for your particular situation and what liabilities may arise. Sometimes the “best way” will change over time.

If you would like to discuss how to structure your business, please do not hesitate to contact Cameron Business Law.