We’re excited to introduce our new blog series: Ask the Expert. It aims to answer the most common questions that we receive from new or prospective entrepreneurs. On today’s edition, we feature Christine Burchett, a lawyer with Burchett Law.
To incorporate or not incorporate, that is the question. Also, do I need a lawyer? What are the pros and cons of a sole proprietorship? Christine Burchett has heard it all. We sat down with her and asked: “what are the top five questions you hear from entrepreneurs?”
In this blog post:
- Q1: Should I incorporate my business?
- Q2: What is the difference between a sole proprietor and an incorporated company?
- Q3: Do I need a lawyer to incorporate a company?
- Q4: Do I need a shareholder agreement?
- Q5: Should I incorporate in Ontario or federally?
Q1: Should I incorporate my business?
Several factors influence whether an incorporated company is the most appropriate business structure. The below table is a useful guide in showing which business structure may be right for you. Consider the items in the first column and ask yourself what your risk level is, how much capital you’re working with, and so on.
|CHARACTERISTIC||SOLE PROPRIETORSHIP||GENERAL PARTNERSHIP||LIMITED PARTNERSHIP||INCORPORATION|
|Cost of set-up||Least expensive||Moderate||Moderate||Expensive|
|Jurisdiction||Provincial||Provincial;||Provincial||Provincial and/or Federal|
|Start-up capital||Personal savings, loan, etc.||Combined personal resources||Combined personal resources||Personal savings, loan, Venture or Equity capital|
|Raising capital||Difficult||Difficult||Less difficult||Less difficult|
|Tax filings||Personal only||Personal only||Personal only||Personal and corporate|
Q2: What is the difference between a sole proprietor and an incorporated company?
With this type of business organization, you are the sole owner, and fully responsible for all debts and obligations related to your business. All profits are yours to keep. Because you are personally liable, a creditor can make a claim against your personal assets as well as your business assets in order to satisfy any debts.
- Easy and inexpensive to register
- Regulatory burden is generally light
- You have direct control of decision making
- Minimal working capital required for start-up
- Some tax advantages if your business is not doing well (for example, deducting your losses from your personal income, and a lower tax bracket when profits are low)
- All profits go to you directly
- Unlimited liability (if you have business debts, claims can be made against your personal assets to pay them off)
- Income is taxable at your personal rate and, if your business is profitable, this could put you in a higher tax bracket
- Lack of continuity for your business if you are unavailable
- Can be difficult to raise capital on your own
A partnership is a non-incorporated business that is created between two or more people. In a partnership, your financial resources are combined with those of your business partner(s), and put into the business. You and your partner(s) would then share in the profits of the business according to any legal agreement you have drawn up.
In a general partnership, each partner is jointly liable for the debts of the partnership. In a limited partnership, a person can contribute to the business without being involved in its operations. A limited liability partnership is usually only available to a group of professionals, such as lawyers, accountants or doctors.
When establishing a partnership, you should have a partnership agreement in place. This is important because it establishes the terms of the partnership and can help you avoid disputes later on. Hiring a lawyer or other legal professional to help you draw up a partnership agreement will save you time and protect your interests.
- Fairly easy and inexpensive to form a partnership
- Start-up costs are shared equally with you and your partner(s)
- Equal share in the management, profits and assets
- Tax advantage — if income from the partnership is low or loses money (you and your partner(s) include your shares of the partnership in your individual tax returns)
- There is no legal difference between you and your business
- Unlimited liability (if you have business debts, personal assets can be used to pay off the debt)
- Can be difficult to find a suitable partner
- Possible development of conflict between you and your partner(s)
- You are held financially responsible for business decisions made by your partner(s); for example, contracts that are broken
- Legal issues for small business (Link to Government of Canada website)
Do you really need a lawyer when you start your small business? Find out how legal counsel could benefit your business.
Another type of business structure is a corporation. Incorporation can be done at the federal or provincial/territorial level. When you incorporate your business, it is considered to be a legal entity that is separate from its shareholders. As a shareholder of a corporation, you will not be personally liable for the debts, obligations or acts of the corporation. It is always wise to seek legal advice before incorporating.
- Limited liability
- Ownership is transferable
- Continuous existence
- Separate legal entity
- Easier to raise capital than it might be with other business structures
- Possible tax advantage as taxes may be lower for an incorporated business
- A corporation is closely regulated
- More expensive to set up a corporation than other business forms
- Extensive corporate records required, including documentation filed annually with the government
- Possible conflict between shareholders and directors
- You may be required to prove residency or citizenship of directors
Q3: Do I need a lawyer to incorporate a company?
Anyone is able to complete and submit the two forms necessary to incorporate a numbered company. However, submitting the two forms is just the first of many legislatively-mandated activities to be performed when starting a new business or changing your business structure from a sole proprietor to an incorporated entity. To ensure you understand what it means to have an “incorporated” company, please seek both financial and legal advice before going down the path of incorporation.
Q4: Do I need a shareholder agreement?
Any time there is more than one shareholder, it is recommended the parties also enter into a Shareholder Agreement while the shareholders are all getting along. The Shareholder Agreement set out the terms and conditions governing the actions and activities of the shareholders in the event of a breakdown in the relationship between / amongst the shareholders. The Shareholder Agreement also accomplishes, amongst many things, what happens if a shareholder becomes mentally incapable of taking care of her affairs or passes away or receives an offer to buy her shares from a third party. Please seek legal advice about whether a shareholder agreement is right for you, and what concerns you may wish addressed in the agreement, from a lawyer who is familiar with such agreements.
Q5: Should I incorporate in Ontario or federally?
There are three basic differences between provincial and federal incorporation: Jurisdiction of operation; degree of corporate name protection and cost of incorporation. Here are a handful of basic questions where your answers will determine which jurisdiction (a province or provinces vs. federally) you may wish to incorporate in:
- Where will your corporation conduct its business – in one or more provinces/territories or across Canada?
- How important is federal name protection? Will your corporate name be used in multiple Provinces or Territories?
- Does the uniqueness of your corporate name justify its protection with federal incorporation?
- What are the various fees associated with federal incorporation versus provincial incorporation?
Depending on your answers, you may want to consider either provincial or federal incorporation.
And that’s it for this edition of Ask the Expert! Thank you to Christine Burchett for dedicating her time and providing her valued insight. Stay tuned for the next edition of Ask the Expert, and subscribe to our newsletter here so you can stay up to date on the latest posts! Still have burning questions you need answered? Book a one-on-one consultation with a YSBEC expert today!
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