Determining the Best Business Structure: The Pros and Cons of Operating as a Corporation, Partnership, or Sole Proprietorship

When starting a business, one of the first decisions you'll have to make is selecting the business structure through which you will operate. Determining the best business structure is a significant choice because it can have an impact on tax obligations, operational complexity, and liability concerns.

In broad terms, there are three business structures to consider. First, a business can operate as a corporation, which may be either provincially or federally incorporated in Canada. Second, two or more business partners may form a partnership. A partnership can take the form of a general partnership, a limited partnership, or, for certain professions, a limited liability partnership. Each option has distinct advantages and drawbacks, which makes it essential for aspiring entrepreneurs to thoroughly evaluate which structure aligns best with their goals and resources.

Understanding the intricacies of these business structures is vital, as it sets the foundation for how your business will operate and grow. In general, it is possible to alter a business' operational structure after it has been established, but starting with the structure that best aligns with your unique goals is preferable because it reduces future concerns and may save a significant amount of money in the long run. In this blog post, we will discuss the specific details of each structure and explore their pros and cons.

Corporations

Corporations are entities that are separate from their owners. They are more complex to establish and operate than other business structures, but this separation can offer distinct advantages and protections that make this structure an appealing choice for many entrepreneurs.

In Canada, a corporation can be incorporated under either federal or provincial jurisdiction. The main difference relates to the governing statute, with federally incorporated companies being required to operate pursuant to the Canada Business Corporations Act and provincially incorporated companies being regulated by the applicable provincial equivalent, which is the Business Corporations Act (Ontario) for the Province of Ontario. There are other differences stemming from the jurisdiction of incorporation that largely relate to name protections and filing requirements, but these are usually not significant considerations for most businesses.

Certain regulated professionals, such as lawyers, accountants, and physicians, are permitted to establish professional corporations. A professional corporation offers a somewhat unique set of liability protections that relate to the regulatory requirements governing each respective profession. Additionally, there are numerous other requirements that these corporations must satisfy on an ongoing basis. In general, these relate to share ownership, the identity and qualifications of officers and directors, the business activities that the corporation may carry on, and how funds are to be managed. However, as mentioned, only certain regulated professionals may establish a professional corporation.

Pros of Corporations

1. Limited Liability: Shareholders enjoy limited liability protection, which means that they are generally not personally responsible for the business’s debts or liabilities and that their risk is limited to the amount of their investment. This protects personal assets from business-related risks, but certain agreements entered into by the corporation may require personal guarantees from the individuals involved in the operation of the business of the corporation that impact their limited liability protections. Similarly, if a shareholder, or the principal of a shareholder, is a director of the corporation, they may be personally liable for certain obligations of the corporation.

2. Access to Capital: Corporations may be able to raise capital more easily through the sale or issuance of shares, attract investment, and access various forms of financing.

3. Perpetual Existence: Corporations continue to exist beyond the lives of their owners. This provides stability and continuity, which can be appealing for long-term businesses. Additionally, they often form an essential part of more complex estate planning matters.

4. Tax Planning: Shareholders can receive dividends or draw a salary if they are actively involved in the business, which allows shareholders to receive money in the form that is most preferable for them. However, an important consideration when structuring the corporation is that, when declared, dividends must be issued equally to all holders of a particular class of shares. As a result, care must be taken to ensure that an appropriate number of share classes are authorized and that each share class has appropriate rights attached thereto. As an added potential bonus, earnings can be retained in the corporation, which are generally taxed at a more preferable rate than if they were to be distributed to individual shareholders.

5. Operational Flexibility: The ability to issue shares allows for business partners or outside investors to be added relatively easily. However, as mentioned, care must be taken to ensure that the right number of share classes are authorized and that the share classes have the proper rights attached thereto. A corporation's Articles of Incorporation can be amended to remedy an issue, but it's always preferable to start with a properly structured company.

6. Flexibility in Management: The company's officers and directors run the business of the corporation. In many cases, these are some or all of the shareholders, but they do not have to be. The company's shareholders elect its directors, and the directors then appoint officers. This allows for a flexible and easily adaptable management structure, as individuals can be involved in the company's operations in various roles and capacities, and absent conflict, it is generally fairly straightforward to add or remove titles.

7. Perception: Although subjective, a business operating as a corporation may appear more established and appealing to potential customers, employees, suppliers, and others who may interact with the business.

   
   

Cons of Corporations

1. Complexity and Costs: The formation and maintenance of a corporation comes with notably more regulatory requirements and associated fees than if one were to operate as a sole proprietorships.

2. Administrative Burden: Along with other general requirements, a corporation must maintain its minute book. This includes, amongst many other things, passing resolutions related to the appointment or removal of officers or directors, documenting and approving a change in the corporation's registered office address, approving the issuance of shares, and maintaining the various registers and ledgers.

3. Decision Making Difficulties: In the case of a corporation with multiple shareholders who each hold voting shares, there can be issues related to the approval of certain actions if the partners do not agree. This can be proactively dealt with through the implementation of a shareholder's agreement, but care must be taken to ensure that the language used in the agreement accurately reflects the intentions of the parties. Certain voting matters can also be dealt with through the passage of certain types of resolutions, but business owners should similarly ensure that the language of any such resolution accurately reflects the intentions of the parties and that the resolution has been properly passed.

   
   

Verdict: A corporation is often the preferred choice of many entrepreneurs due to the flexibility that it offers, including considerations related to both tax planning and operations. The potential for limited liability is also a consideration that generally weighs in favour of operating a business through a corporation. However, there are a number of additional administrative requirements that come with operating a corporation, including regulatory filings, the need to prepare a separate tax filing, and the requirement to maintain a properly updated minute book, that may make it somewhat less appealing to those who are looking to operate a more casual business.

Partnerships

Partnerships involve two or more business partners who share ownership of a business. Partnerships are relatively easy to establish, but the partners share responsibility for the operation of the business of the partnership and also share any profits generated by the business. Additionally, partnerships should be registered. From a tax perspective, partnerships are viewed as "flow-through" entities that are not taxed themselves, which has the potential to create a desirable or undesirable situation for each partner, the determination of which depends on each partner's individual financial situation.

There are three different types of partnerships in Ontario, and there are notable differences between each type.

A general partnership is what many may think of when they think of operating a business as a partnership. This business structure involves two or more business partners operating together with a view towards generating profit. As a result, each partner shares in both the liabilities and any profits generated by the partnership.

A limited partnership operates as something of a hybrid structure that includes characteristics of both a corporation and a general partnership. A limited partnership includes at least one limited partner and at least one general partner. Each limited partner enjoys a limited liability status that is comparable to how shareholders of a corporation are treated, but they can lose this status if they become involved in the operation of the business of the partnership. A general partner is responsible for operating the business of the partnership, which would include entering into contracts and making all key business decisions on behalf of the partnership, but the general partner also attracts all of the liability for the partnership. It is possible to create a limited partnership where a corporation that is owned and operated by the limited partners operates as the general partner, but the limited partners must still be sure to not operate the business of the partnership in their capacity as limited partners.

A limited liability partnership is a business organization that is available to only certain regulated professionals, including lawyers and accountants. The establishment and operation of a limited liability partnership works in conjunction with the laws that regulate each applicable profession, but this structure may offer certain advantages to these professionals.

Pros of Partnerships

1. Shared Decision-Making: Partnerships can leverage the skills and expertise of each partner, facilitating collaborative decision-making.

2. Pooling of Resources: Partners can combine their financial resources, contacts, and expertise to start and grow the business more robustly than a sole proprietor might be able to do alone.

3. Flexibility in Management: Partnerships allow for flexible management structures and can be tailored to fit the specific needs and agreements of the partners involved. In particular, additional business partners or outside investors can be added at any stage in a manner similar to how a corporation may do so.

4. Flexibility in Ownership: Partners in a partnership can be individuals, corporations, or even other partnerships. This allows for a flexible ownership structure that can allow each partner to be involved in the partnership in a manner that is best for them and the partnership when factors such as tax obligations and operational control are considered.

5. Potential Limited Liability: Limited partners in a limited partnership do enjoy limited liability status, but they must be sure to not actively engage in the management of the business of the partnership in order to retain this status.

   
   

Cons of Partnerships

1. Joint Liability: In general partnerships, each partner is personally liable for the debts and obligations of the business. This can somewhat be remedied through the establishment of a limited partnership, but doing so introduces an additional level of operational complexity and the general partner does retain liability regardless.

2. Potential for Conflict: Differences in vision, work ethic, and goals can lead to disputes among partners, which could hinder business operations.

3. Administrative Obligations: Every partnership should have a partnership agreement that outlines, amongst other things, how the business is to be managed, how disputes can be rectified, and how partners can exit or enter the partnership. Additionally, partnerships should maintain a record book that details that actions taken and approved by the partnership. A partnership should also issue unit certificates that evidence the ownership interest that each partner has in the partnership.

4. Title to Property: Partnerships are not able to hold title to property because of their legal status. There are ways this can be navigated and it may not be a concern for the majority of businesses, but it can be a significant consideration for businesses that are looking to own real estate.

   
   

Verdict: The partnership can be an excellent choice of business structure for many businesses because of its flexible management and organizational structure. However, there may be liability concerns. These concerns can be addressed through the formation of a limited partnership, but business owners must be sure to establish and operate a limited partnership in accordance with legal requirements to ensure that the limited liability status of limited partners is both initially established and maintained. Additionally, although the administrative burden of operating a partnership is generally less than that which is associated with a corporation, it can be significant.

Sole Proprietorships

A sole proprietorship is the simplest form of business organization. This type of business is operated by its sole owner and is not an entity that is legally separate from its owner. This means that the owner has complete operational control of the business, but it also means that the owner os generally liable for all of the obligations of the business.

Pros of Sole Proprietorships

1. Ease of Formation: Sole proprietorships are straightforward to establish. You can start your business without having to register with the provincial government, although some local registrations may still be necessary.

2. Complete Control: As the sole owner, you have total autonomy over every aspect of your business.

3. Tax Simplicity: Business income is reported on the owner's personal tax return, which can simplify tax filings. However, business owners should be aware that the simplest filing process may not be the most efficient.

Cons of Sole Proprietorships

1. Unlimited Personal Liability: The owner is generally personally responsible for all debts and liabilities incurred by the business. This means that personal assets can be at risk if the business faces financial troubles.

2. Limited Resources: Sole proprietorships may struggle to raise capital, as funding options are often limited to personal savings or loans.

3. Lack of Flexibility: Given that this business structure can't issue shares or partnership units, a business partner or other investor cannot easily be added to the business. Similarly, if the owner decides to sell the business, the ways in which the transaction can be structured are limited and the owner likely would not be able to claim the Lifetime Capital Gains Exemption without a significant reorganization of the business that is done well in advance of the completion of the transaction.

4. Registrations may be Required: Although one of the benefits of a sole proprietorship is that it offers a structure that is easier to operate, certain registrations or filings may still be required. For example, a business name would have to be registered if the sole proprietorship looks to use any name other than the full legal name of its owner.

5. Personal Tax Concerns: It is relatively simple to file taxes related to income generated by a sole proprietorship, but this can create an inefficient tax structure for the business and its owner. This determination would be based on a number of personal considerations, including the overall profit generated by the business and whether the owner has other sources of income.

Verdict: The sole proprietorship can be a preferable structure for some small businesses, but these are often limited to early-stage businesses that do not require significant startup capital, will not be hiring staff or looking to potentially involve other business partners, and will not be looking to significantly expand operations. Additionally, there may be notable tax consequences for an owner who has sources of income other than the business.

Conclusion

The choice of business structure can have a notable impact on the future of your business. Each option has its unique set of features, pros, and cons, and being properly advised on these distinctions will ensure you are positioned in a way that best aligns with your unique business goals, financial situation, and personal preferences.

For small business owners, the ideal structure will depend on factors such as potential liability protections, ease of formation and maintenance, tax implications, the number of individuals involved, and management style. Adopting the right business structure not only lays the groundwork for future growth, but also sets the stage for long-term success and serves as the foundation for all future business activities.

With expertises in business establishment and management across a range of industries, ZG Law Professional Corporation can provide sound legal advice that is catered to your individual needs and is able to assist with any matter related to business establishment or maintenance, regardless of whether (you are considering starting a new business, would like to adjust the way in which your business operates, or would siply like to ensure that you are compliant with regulations and stuff)