Starting a Business: 3 Types of Business Structures in Ontario
Starting a Business in Ontario? Here’s What You Need to Know About Business Structures.
Thinking of setting up shop?
Just like in many places, you’ve got a few options for how to structure your business.
In Ontario, you can pick from various types: a sole proprietorship (that’s just you running the show), a partnership (teaming up with others), or a corporation (a more formal setup existing as its own legal entity).
If you’re bringing a business from overseas, you can also get things rolling through a branch operation or by joining forces with a local business in a joint venture.
The best fit for your business depends on what you’re doing, where you’re doing it, the risks involved, how you plan to fund your business, and, of course, taxes.
1. Sole Proprietorship: The Solo Operation
Think of a sole proprietorship like a one-person show. It’s the go-to choice when you’re the sole owner and operator of your business, along with handling all the risks and responsibilities.
This setup is pretty straightforward without many legal hoops to jump through. But remember, you’ll still need to tick off some boxes like getting the right licenses and registering your business name. It’s a great fit for smaller businesses but remember, this option means that everything – the good and the bad – directly affects you, the owner.
Your personal assets, like your car or savings, could be on the line if your business hits a rough patch. This is unlike a corporation where there is a boundary of sorts between your personal assets and your business debts. Without giving tax advice here because that’s to be confirmed by you and your accountant – general knowledge is that when it comes to taxes as a sole proprietor, your options are more limited since profits are taxed as your personal income.
Pros of a Sole Proprietorship:
- Ease of Establishment and Operation: Starting and running a sole proprietorship is straightforward, involving minimal bureaucracy and paperwork. It offers a more direct path to business ownership.
- Complete Decision-making Authority: As the sole owner, you have most control over all aspects of your business, allowing for swift decision-making.
- Simplified Regulatory Compliance: Sole proprietorships can face fewer regulations and reporting requirements compared to larger entities, streamlining administrative tasks.
- Direct Financial Rewards: Profits from the business flow directly to you, ensuring that your hard work and dedication are directly rewarded.
- Taxation Efficiency: Reporting business income is on the same page as personal income, simplifying the tax process (with potential deductions for business expenses).
Cons of a Sole Proprietorship:
- Personal Liability Exposure: There’s no separation between personal and business liabilities, putting personal assets at potential risk in the event of business debts or legal issues.
- Limited Funding Opportunities: Accessing capital can be more challenging, as financial institutions and investors may perceive sole proprietorships as higher-risk ventures.
- Growth Constraints: Expanding the business may be limited by personal financial resources and capacity – potentially hindering scalability.
- Dependency on the Owner: The business’s viability is closely tied to your presence and involvement, with its survival at risk if you are unable to manage it.
- Potential for Higher Self-Employment Taxes: While tax filing can be more straightforward, you may face higher self-employment taxes, and there are fewer opportunities for tax planning compared to other business structures.
Sole proprietorships offer simplicity and control but come with personal liability and potential limitations in growth and financing. They are ideal for those starting small and wanting to keep things easy and straightforward before heading into next steps as they grow.
2. Partnerships: Teaming Up in Business
When two or more people or companies decide to do business together to make a profit, that’s called a partnership. In Canada, the rules for partnerships can vary because each province has its own laws about them. But generally, you’ll find two types: general partnerships and limited partnerships. And here’s a twist: for taxes – partnerships aren’t seen as separate entities. Instead, profits and losses get divided among partners, who then include these in their personal tax returns.
a. General Partnership This is like the all-for-one, one-for-all approach. You don’t always need a formal agreement to start a general partnership, except in Quebec (where their legal system is different). But be careful, as each partner can be on the hook for all the partnership’s debts.
b. Limited Partnership Here, you have at least one general partner running the show and any number of limited partners just investing. The general partners face the music if things go south, but limited partners are only at risk for the amount they put in. The catch for limited partners? They need to stay out of managing the business, and just stay investors, otherwise they can lose that protective “limited” shield.
c. Limited Liability Partnership Some provinces offer this mainly for professional groups like lawyers or accountants. It’s a sweet deal as it limits your liability. If one partner messes up, only their assets are at risk, not everyone’s. But again, this is only available for certain professionals.
Partnerships can be a great way to combine strengths and resources, but they also mean sharing responsibilities. Choosing the right business type is key to balancing the benefits with the risks.
Pros of a Partnership:
- Collaboration: A partnership means you’re not doing it alone. You have partners to share responsibilities, brainstorm ideas, and make key business decisions together.
- Increased Resources: More partners can mean more initial capital and a broader range of skills and contacts. This can be a big boost, especially in the early stages of the business.
- Simplified Taxes: Like sole proprietorships, partnerships benefit from pass-through taxation. This means profits and losses are reported on the partners’ personal tax returns, simplifying the tax process.
- Operational Flexibility: Partnerships offer more flexibility in day-to-day management compared to corporations. They can adapt quickly to changes or new opportunities.
- Credibility: A partnership can bring diverse expertise and reputability, enhancing the business’s image and potential for growth.
Cons of a Partnership:
- Shared Liability: In a general partnership, each partner is liable for business debts and obligations. This shared liability can pose significant financial risks.
- Potential Conflicts: Differences in opinions and management styles among partners can lead to conflicts, which may affect the future of business operations and decision-making. Reaching consensus on business decisions can be challenging and time-consuming with more partners involved.
- Instability in Structure: The departure or death of a partner can affect the business’ continuity. Partnerships often need to be restructured or dissolved under these circumstances.
- Funding Limitations: Despite pooled resources, partnerships might still face limitations in raising additional capital, as they can be seen as riskier ventures by lenders compared to corporations.
In sum, while partnerships offer collaboration and flexibility, they also require careful consideration of shared risks and responsibilities.
3. Corporations: The Formal Business Structure
Imagine a corporation as its own person, or its own entity, legally speaking. In Canada, a corporation can own property, do business, borrow money, and even find itself in court. It stands apart on its own from the people who invest in it – the shareholders.
What Makes a Corporation Special?
- Limited Liability: Shareholders aren’t usually on the hook for the corporation’s debts. They can sleep easier knowing their personal assets are generally safe.
- Continuity and Transferability: A corporation can outlive its founders, surviving ups and downs, with the ability to sell or transfer it to others, if needed.
- Tax Matters: Corporations pay their own taxes, separate from their shareholders. This is a key difference from other business structures.
- Common Choice: Many Canadian businesses opt for this structure for its stability and features.
Incorporation Options: Federal or Provincial
You can set up your corporation under federal or provincial law. The choice depends on where you’re doing business, director residency requirements, name options, and costs. If your business sector is in areas of banking or other federally regulated areas, federal incorporation is a must. And if you’re spanning multiple provinces, get ready to consider registering in each one.
Public Disclosure: What you need to disclose publicly about your corporation varies based on where you’ve incorporated, where you operate, your business type, and whether you’re publicly traded or not.
The Corporate Trio: Officers, Directors, and Shareholders
- Officers handle day-to-day operations.
- Directors are appointed by shareholders and oversee the corporation’s direction and policy.
- Shareholders own shares in the corporation but don’t manage daily affairs.
In smaller private companies, one person might wear all these hats, but in public companies, these roles are usually distinct.
Residency Requirements for Directors
If you’re a foreign investor, note the residency requirements. Federally, you need at least 25% of directors to be Canadian residents. In Ontario, the rules recently changed – directors do not need to be Canadian residents.
Pros of Forming a Corporation:
- Limited Liability: Shareholders have peace of mind knowing their personal assets are generally protected if the corporation faces financial trouble.
- Perpetual Existence: Corporations continue to exist even if ownership changes or original founders leave, providing stability and a sense of continuity.
- Funding Opportunities: Corporations often find it easier to get out there and raise capital, either through selling shares or accessing other financing options.
- Credibility: Incorporating can boost your business’s credibility, making it more appealing to customers, suppliers, and investors, by making it a surviving entity of its own.
- Tax Advantages: Corporations may benefit from lower corporate tax rates and may have more opportunities for tax planning compared to sole proprietorships or partnerships.
Cons of Forming a Corporation:
- Complexity and Cost: Incorporating involves more paperwork, legal requirements, and higher initial costs than other business structures.
- Regulatory Requirements: Corporations face more regulatory scrutiny, including ongoing filing and reporting obligations.
- Double Taxation: In some cases, profits can be taxed twice – first at the corporate level and then as dividends to shareholders. Ask your accountant.
- Decision-Making Processes: Corporations often require more formal decision-making structures, which can slow down the process and reduce flexibility.
- Residency Requirements for Directors: For foreign investors, the residency requirements for directors in certain jurisdictions can be a limiting factor.
Corporations offer significant advantages in terms of liability protection and potential for growth, but they come with their own set of complexities and regulatory requirements. It’s a structure well-suited for businesses aiming for longevity and large-scale operations.
Navigating the business landscape requires planning, foresight, and guidance. Contact us if you’re thinking about setting up your business – we’re happy to help put you in the right direct.
Ask us about our SMB Launchpad too!