The Pros and Cons of Different Business Structures
Whether you’re starting a new small business or trying to expand an existing one, it’s important to consider the legal structure that is the best fit. The choice generally depends on the specific type of business you’re in, the number of owners or investors you have, and the potential impact of tax and liability concerns.
Making the smart choice could save you money, not to mention serious legal consequences, so take the time to understand the difference between the three main options and the advantages and disadvantages of each.
The most basic type of business structure, a sole proprietorship is best suited to new businesses, particularly small scale operations. Profits go directly to the sole owner, but that person is also liable for any debts the business incurs, with no protection for personal assets. Income is taxed at the personal rate, which could be costly if profits result in the owner moving into a higher tax bracket. However, losses and business expenses can be deducted from personal income, providing some tax relief.
A partnership is an unincorporated business formed between two or more people who agree to combine their resources, financial or otherwise. Profits are shared in accordance with the agreement made between the parties whenever the partnership is first formed.
Generally easy and inexpensive to establish, partnerships add credibility, protect the business name, and allow for losses and expenses to be deducted from income. However, that income is taxed at the personal level, and the partnership offers no liability protection from the debts and actions of fellow partners, who may also squabble over business decisions.
Some types of professionals, such as doctors, lawyers, and accountants, are eligible to form limited liability partnerships. This structure does offer protection from the actions of other partners.
Incorporating your business creates a corporation that exists as a legal entity separate from its shareholders and directors. The corporation is liable for its own debts, pays tax on its income, and can sell shares to raise money.
There are several advantages to incorporating. The owner of an incorporated business draws a salary and pays personal income tax. Money that remains in the business is taxed at the more favourable corporate tax rate. Additionally, owners cannot be held personally liable for the debts, obligations or acts of the corporation, and an owner’s personal assets remain separate from the business. Incorporating can boost the credibility of your business with prospective clients, and make it easier to raise capital by selling shares.
Corporations are closely regulated, however, and there are costs associated with meeting the both legal requirements of establishing the business, and the annual filing of corporate records.
One common Canadian business structure is a limited corporation or company, designated by the letters Ltd. at the end of the business name. In this arrangement, the liability of directors and shareholders with regard to company debts corresponds to their own level of investment.
If you are considering changing the structure of your business, it’s wise to seek legal advice first, and to get professional assistance with any required paperwork. Remember that in most cases you will also need to change your business number and update your status with the Canada Revenue Agency.
If you need help incorporating your home business, you can get all the assistance you need from The UPS Store’s Incorporation Guide.