A determinate of business success is created, in part, by choosing the correct legal structure. Some of the advantages of choosing the right structure are:
- Provides the ability to do business with government or large businesses
- Saves money at tax time
- Makes it easier (and cheaper) to pay yourself
- Avoids potential personal legal liability
- Brings revenue earned on foreign sales back to Canada
- Allows you to sell your business or pass it on to successors.
The three basic legal structures are:
1. Sole Proprietorships – You alone own it and are 100% responsible for its debts and liabilities. All earnings are taxed as your personal income. This is the most popular small business structure because its’ simple and straightforward.
2. Partnerships – Two or more owners agree to share profits and losses according to their share of the firm. In a general partnership all partners are liable for debts; in a limited partnership one or more partners limit their personal liability by being passive investors and not making day-to-day business decisions.
To determine if these structures fit you, consider the following questions. If you answer YES to most the following questions, then a sole proprietorship or partnership is right for you:
- You will be the sole owner or own the business with just a few partners or family members.
- You plan to start the business using only personal savings or investments from friends and family.
- You expect business revenues to support only you and your partners or family members.
- You plan to do most of the work yourself.
- You will borrow personally on behalf of the business.
- You are in a low personal income tax bracket.
- Your business is highly unlikely to face a lawsuit or get into debt.
- Your have a limited net worth (personal worth).
3. Corporations – The company earns revenue, incurs losses and pays taxes separately from its owners. Companies often pay tax at a lower rate than individuals. Owner’s liability is limited to what he/she invests in the company, and they have options as to when and how they take money out of the company.
To determine if a corporation is right for you consider the following questions. If you answer YES to most of the following questions, then a corporation is right for you:
- Ownership will be divided among several shareholders.
- You expect significant start-up costs.
- You will be hiring employees and paying out wages and salaries.
- You will require additional financing beyond savings and investments from family and friends.
- You expect increasing revenues and a rising asset base.
- You will probably need to raise equity or issue debt, either now or later.
- You will put a full management and organizational structure in place.
- You expect to look into income-splitting and tax-deferral options.
- You want to protect your existing substantial net worth.
The legal form of your business will affect everything from the administrative costs of setting up and operating your business through to your tax planning. It’s a decision you need to make even before you choose your business name.
However, that being said, choosing a form of business ownership does not have to be fixed in stone. You can alter your legal structure as your circumstances change, for example, most small businesses start as home-based sole proprietorships that grow to downtown corporations at a later date.
The next section outlines how to register your business once you’ve decided on a structure.