Do you plan starting your own business, but you are not certain which legal structure to choose for operating it? Do you already operate a sole proprietorship, but you want to expand and you are not certain whether its current legal structure still suits the needs of your business?
Those types of questions are normal and the choice to operate a sole proprietorship, a partnership or a business corporation is not always easy to make.
At first, a sole proprietorship may seem the simplest and least expensive choice. However, that does not mean that it is the choice best suited for your needs.
This article is intended as a tool to help you easily understand the main pros and cons of choosing to operate your business as a business corporation, which is commonly identified by the addition of an abbreviation such as "Inc." or "Ltd." in the name or numerical designation of the company.
ADVANTAGES OF INCORPORATING A BUSINESS CORPORATION
1. Limited liability
One of the main advantages of operating a business corporation is that such entity has a legal personality and a patrimony that are distinct from those of its shareholders. In other words, a business corporation exists independently from its shareholders and its assets as well as its liabilities are not combined with those of its shareholders. Thus, the personal assets of shareholders are generally not put at risk in the unfortunate event that the corporation encounters financial difficulties and fails to pay its suppliers or to repay a loan, or even if the corporation faces a civil liability suit for damages caused by a product sold by it. It is only the corporation's assets that can be seized which implies that the loss for each shareholder will then correspond at most to their respective capital contribution in the corporation.
Nevertheless, it should be mentioned that certain financial institutions or suppliers may require a personal security from shareholders in the event the corporation fails to meet its obligations. Thus, this will have the effect of making it possible to engage the personal liability of shareholders, but only to the extent of the corporation's obligations which they have guaranteed.
By contrast, when it comes to a sole proprietorship, said legal structure is simply the continuity of the natural person who operates their business. A sole proprietorship has neither a separate legal personality nor a separate patrimony. Thus, in the event of financial difficulty or a lawsuit, all the personal assets of anyone operating a sole proprietorship are within the reach of its creditors and may be jeopardized.
As for partnerships, subject to certain nuances which are beyond the scope of this article, generally, as is the case for a sole proprietorship, all the assets of the partners can be at risk in the event of a financial difficulty or a lawsuit against the business.
2. Tax benefits
There are several tax benefits associated with operating your company as a business corporation, but it is beyond the scope of this article to explore them in depth. Nevertheless, it is worth making a brief overview of some of those benefits.
In particular, a business corporation offers multiple alternatives for remunerating shareholders and directors. Of course, they can receive a salary and be taxed according to the progressive income tax rate applicable to them. However, they can also receive dividends and thus benefit from an income tax rate which is generally lower or be remunerated in shares of the corporation.
In addition, when a business generates more money than the shareholders and directors decide to pay each other as salary, another advantage of operating a business corporation is that it allows to keep part of the profits within the corporation. Those profits will be taxed at a rate that is generally lower than the progressive income tax rate at which the shareholders and directors will be taxed if they receive large sums of money as salary. Thus, the business corporation will ultimately be able to benefit from a greater capital to invest.
By contrast, a sole proprietorship does not offer the same flexibility. If the business is profitable, the owner of a sole proprietorship must declare all the profits on their personal tax return. Those profits will therefore be taxed according to the progressive income tax rate applicable to individuals.
Similarly, a partnership by itself does not pay income tax on its operating results and does not file an annual income tax return. Instead, each partner must include their share of the partnership income on their personal income tax return and it will therefore by taxed at the progressive income tax rate applicable to individuals. That being said, each partner can sometimes choose to include their share of the partnership income on a corporate or trust income tax return.
Ultimately, it should not be forgotten that in the event of the sale of shares of a business corporation, the shareholders can benefit from their lifetime capital gains exemption and thus obtain a greater return on their investment.
3. Multiple financing streams
A business corporation benefits from traditional sources of financing such as loans. Moreover, obtaining a loan is often easier for a business corporation than it is for an individual. The reason is that the distinct patrimony of a business corporation implies that the personal debts of its shareholders are not considered to be debts of the corporation.
In addition to financing by securing a loan, a business corporation has the possibility to obtain financing by other means. For example, a business corporation may obtain capital by issuing shares to certain family members of directors and officers of the corporation, to employees of the corporation or to accredited investors.
As for sole proprietorships and partnerships, they do not offer the possibility of issuing shares to potential investors and the only means of securing financing is generally by obtaining a loan. It is worth mentioning that if a sole proprietorship or a partnership fails to repay any of its loans, it is all the assets of the owner/partners that may be jeopardized.
4. Credibility
Generally, a business corporation projects an image of professionalism and stability and inspires greater confidence in customers as compared to a sole proprietorship. That being said, each case is unique, and a sole proprietorship can nevertheless have an excellent reputation.
DISADVANTAGES OF INCORPORATING A BUSINESS CORPORATION
1. Higher start-up costs and annual fees
Despite the numerous advantages of operating a business corporation, it should be noted that this type of legal entity is generally considered more expensive than the others.
First, government fees such as incorporation fees are higher for a business corporation than for a sole proprietorship or a partnership. In addition, the annual fees for maintaining a business corporation are also higher. That being said, these fees alone are not enough to justify not choosing to operate a business corporation. For example, at the date of writing this article, the fees payable to the Quebec enterprise registrar for the certificate of incorporation of a provincial business corporation are $367.00 and the fees for filing the annual declaration of a provincial business corporation are $98.00.
By contrast the fees payable to the Quebec enterprise registrar for the certificate of incorporation of a sole proprietorship and for filling the annual declaration are $38.00 each.
As for a partnership, the fees payable to the Quebec enterprise registrar for the certificate of incorporation and for filling the annual declaration are $58.00 each. That being said, in addition to the incorporation fees, for most types of partnerships, it is necessary to incur additional professional fees for drafting a partnership agreement in order to validate the legal structure chosen by the partners.
Other than the government fees which are higher for a business corporation as compared to other legal entities, in general, the organization of a business corporation also generates higher costs, in particular for keeping a minute book. Also, it is advisable, but not mandatory, to have a shareholder agreement in place which will incur additional professional fees to draft.
2. Extensive administrative formalities
At first glance, operating a business corporation may seem complex from an administrative perspective.
Firstly, a company minute book must be kept up to date as well as several registers, including a register of shareholders, directors and share transfers.
In addition, the operation of a business corporation requires, with some exceptions, the creation of a board of directors. Added to this is also the obligation to hold annual general meetings of directors and shareholders or to draft resolutions in lieu thereof.
By contrast, a sole proprietorship is the legal entity that allows to operate a business with the least administrative formalities. Barring certain exceptions, those who operate a sole proprietorship under a name including their surname and first name are not required to register with the Quebec business registrar and to follow any of the formalities arising from such registration.
Moreover, the operation of a partnership is also considered simpler than that of a corporation.
CONCLUSION
In conclusion, although the incorporation and operation of a business corporation are a little more expensive and complex, the many advantages associated with this legal structure often make it a preferred choice over a sole proprietorship or a partnership.
In particular, the limited liability of a business corporation, subject to certain exceptions, means that the personal assets of shareholders are protected from the corporation's creditors. In addition, this legal structure offers more flexibility with regard to the remuneration of shareholders and directors while allowing surplus profits to be kept in the corporation in order to be reinvested. Finally, a business corporation provides access to a variety of financing methods in addition to making the corporation more credible in the eyes of customers.
Do not hesitate to contact us if you need more information on the choice to incorporate a business corporation in order to operate your business.
This article provides general information only and is not intended to provide specific legal advice. You should consult a professional, such as a lawyer, before making any decision on any matter to which this article refers.
Author:
Me Petar Stoyanov
Lawyer / Founder
T: 514.316.0216 ext. 102
F: 438.476.0376
petar.stoyanov@canlexavocat.com