This blog post is not a comprehensive summary of sole proprietorships, partnerships or corporations. It is intended to provide a brief description of each, and some general considerations to take into account when deciding how to best structure your next business venture. In all cases, the legal vehicle through which you choose to conduct business will be highly dependent on your particular circumstances. You will likely wish to consider the nature and scope of liability associated with the business, the assets you own, your appetite for risk, your income, the business’ potential for future earnings, tax implications, and the relationships between those involved.
I. SOLE PROPRIETORSHIPS
These are the oldest and simplest forms of business organizations. Sole proprietorships are unincorporated and consist of a single owner, or proprietor. Accordingly, sole proprietorships automatically dissolve upon the death of the proprietor. Nothing in law prevents a sole proprietorship from becoming a large and powerful enterprise. However, most tend to be small and localized.
Sole proprietorships are easy to start and dissolve, largely as a result of decreased paperwork and administrative overhead. Decision-making tends to be easier because there is only one controlling mind behind the business. There are no registration requirements as long as the proprietor uses their own name; however, if you wish to use a trade name this must be registered with corporate registries. Business income is treated as personal income of the proprietor, which allows any business losses in the start-up phase to offset the proprietor’s personal income. Sole proprietorships are not required to file separate tax returns.
The primary risk in carrying on business as a sole proprietorship is that the business and the person are not distinct legal entities, which means the proprietor is personally liable for all debts and obligations incurred by the business. As a result, the proprietor is exposed to potentially unlimited liability. It can also be difficult to raise capital as a sole proprietor, because investors may only draw on the proprietor’s personal assets to secure an equity investment. Although flowing income through the proprietor may be advantageous early on, if the sole proprietorship becomes extremely profitable it may attract large tax liability.
Section 2 of the Partnership Act (Alberta) defines a partnership as the relationship that subsists between persons carrying on a business in common with a view to profit. Although section 4 of the Partnership Act provides some general guidelines for determining whether a partnership exists, parties are generally free to structure partnerships as they please by agreement. This typically involves the execution of a partnership agreement, which determine the rights and responsibilities of the partners. Some of the factors a court will consider in determining whether a partnership exists are: sharing profits and losses, joint ownership, holding out to be a partnership, shared control of the business, express partnership agreements, capital contribution, access to information, signing authority, and full-time involvement in the business of the partnership. Special types of partnerships, such as limited liability partnerships, are also available to professionals who are restricted from operating as ordinary business corporations.
Partnerships are attractive business models for short-term ventures in that they are relatively easy to form, flexible in design, and easy to dissolve. Personal tax deductions can be realized when a partnership loss is incurred. Well-drafted partnership agreements can be prepared to ensure a partnership is structured as effectively as possible for the purposes of the business, which allows an additional level of control.
Similar to a sole proprietorship, partnerships are not distinct legal entities. Each partner is exposed to unlimited liability in relation to the debts and obligations of the partnership, except in cases of limited partnerships, wherein limited partners are only liable to the extend of their investment provided they are not involved in the operation of the business. It is also important to note that any personal property brought into the partnership or acquired by the partnership in the course of business cannot be sold without the consent of the partners.
Corporations are the preferred business vehicle for high risk ventures. As defined in section 1 of the Business Corporations Act (Alberta), a corporation means a body corporate incorporated or continued under the Act which has not been discontinued. Importantly, it is a distinct legal entity which is separate from that of its shareholders.
Because a corporation has its own legal personality, it can be sued in its own name. This allows shareholders and directors to protect their personally held assets in the event the corporation becomes liable to pay a sum of money, even if the corporation does not have sufficient assets to satisfy the debt or judgment on its own. In this sense, shareholders are only liable to the extent of their investment in the corporation. This concept is sometimes referred to as the ‘corporate veil’. Corporations take on a life of their own, and their succession is not affected by the death or retirement of its owners or directors. Corporations may also be structured with a view to obtaining tax advantages.
While corporations offer enhanced protection from liability, there are some associated costs which should be balanced against the benefits of limited liability. At the front-end, although relatively insignificant, there are costs associated with incorporation, registering a business name, and other related items required to get your business up and running. Corporations are also required to file annual returns as a going concern. In order to operate in another province, corporations must either obtain federal incorporation or extra-provincial registration. Finally, corporations are required to hold meetings, elect directors, and provide shareholders with information. The ‘corporate veil’ may also be pierced in situations involving extreme misconduct, for example, where its controlling mind acts in a fraudulent or deceptive manner in order to gain an advantage. In these rare cases, the court may disregard the corporation’s separate legal personality and attach liability to the individuals behind the corporation.