If you are operating a business in Canada, you have three choices in terms of the legal structure:
As a Sole Proprietorship, the business is NOT a separate legal entity. The business owner directly owns the assets of the business and is directly responsible for the liabilities of the business. If the business has a separate name from the owner’s name, you need to register the business name with the applicable Corporate Registry.
The lack of liability protection is the biggest potential CON of a sole proprietorship. A business owner can reduce the risks of liability to the individual business owner through commercial insurance. Find a broker who can review your current coverage and shop for the best prices for you.
Using disclaimers on your website, limitation of liability clauses in contracts and waivers with clients and customers can also help to reduce liability risks of a sole proprietorship.
The legal definition of a Partnership is "Two or more people carrying on a business in common, with a view of profit" (from the Partnerships Act (NS).
If a business meets the definition of a Partnership, the business falls into the default partnership rules, whether the partners intend to or not - even if you are not registered. Each province or territory in Canada has a Partnerships Act which sets out the default rules for partnerships. You can make your own partnership rules in a Partnership Agreement.
A Partnership Agreement is an agreement between the Partners stating how they will make decisions, share profits and expenses and how the partnership can add partners or end.
When you operate your business as a Partnership, the business is NOT a separate legal entity from the Partners. The business jointly owns the assets of the business with the Partners and the Partners are jointly and severally liable for the liabilities of the business. The name of the Partnership needs to be registered with the applicable Corporate Registry. The Partners of a Partnership are HIGHLY recommended to have a Partnership agreement to govern their relationship and decision making.
Make sure that you know your prospective Partner REALLY WELL and trust their judgment in making all types of business decisions.
Have a set procedure in the Partnership Agreement to approve decisions including financial ones over a certain $$ threshold.
You can have a combo legal structure by having a corporation as a Partner in the Partnership instead of you as an individual (talk to CPA about this one).
If you want to work with another professional, you can have a contractual relationship (and share expenses and co-own assets) rather than having a full partnership where you share profits and liabilities.
When your business is incorporated, the business is FORMED as a separate legal entity from the owner. The CORPORATION owns the assets of the business NOT the individual owner and the Corporation has primary responsibility for the liabilities of the business.
A Corporation will be formed either provincially/territorially OR federally with the applicable Corporate Registry.
A business can be incorporated before it starts operations or it can be incorporated after being a sole proprietorship or a partnership for a period of time first. The timing of incorporation depends on when the benefits of incorporation outweigh the costs of incorporation.
Note: if a business is incorporated after operating as a sole proprietorship or as a partnership for a period of time, the owner should have a conversation with an accountant (CPA) to determine whether extra tax steps (a “rollover”) are required upon this type of incorporation.
There are a number of factors that can give you a compelling reason to incorporate your business. If you would rather review these reasons in the form of an incorporation quiz chart, click the link.
Doing business as corporation will give you a layer of liability protection because the corporation is a separate legal entity. It is the corporation (not you or you and your partners) who are responsible for the liabilities from contracts, employees, debt etc.
There are some exceptions where directors may have liability for tax and under certain other statutes (environmental and occupational health and safety). These exceptions are so that owners can not hide behind their corporations.
There are certain tax planning strategies that can only be used if your business in corporation form. Once you hit a certain level of profit, and particularly if you do not need to take all of the $$$ out of the corporation, you may be able to save or defer tax with a corporation. If you anticipate selling your business in the future, you may also be able to access the capital gains exemption for small businesses.
Many businesses that are getting ready for investment decide to incorporate. Being able to issue shares to investors requires incorporation. The nature of shares makes them more easily divisible into different percentages with different rights and characteristics.
Some businesses may also be required to incorporate if they are applying for certain government funding programs.
I have incorporated hundreds of corporations (probably actually thousands but I have not been counting) over my 20 years of practicing law. A surprising number of business owners have reported to me that they had a mindset shift after they incorporated. They "felt like it was more real" and "felt ready to play a bigger game". Creating a separate entity had an impact on the way that they felt and treated their business.
I hope that this article has given you some more information about corporations and the differences in legal structures. If you want to review this in an infographic, you can check out the incorporation quiz. If you are ready and want to DIY your federal incorporation, you can also check out the DIY Incorporation Package in my online store.