Company, sole proprietorship, general partnership, limited partnership, corporation, LLC, S-Corp, C-Corp. Hold the phone. What do all of those terms mean and how do you decide which one of those business structures to choose for your business?

Let’s start by clearing the table a little bit. Corporations and companies are the same thing. Limited liability corporations (LLC), S-corporations and C-corporations are all American business structures which don’t exist in Canada, we just have corporations. Let’s now go through our four remaining options: sole proprietorships, general partnerships, corporations and limited partnerships.

Sole Proprietorships

A sole proprietorship is the most basic of business structures. If tomorrow you decide to open a lemonade stand in front of your home, you are operating a sole proprietorship. Sole proprietorships are simply businesses which are owned by a single person without any further formalities. If there is more than one owner, the sole proprietorship is transformed into a general partnership as sole proprietorships are limited to one single owner.

Sole proprietorships do not create a distinction between their owner and the business. What does that mean? The owner reports the business’s profits and losses on his or her own personal income tax returns. If the business contracts with someone, the co-contracting party is actually contracting with the business’s owner as the business is not its own distinct legal entity. That said, a sole proprietorship can have employees or contractors, there is just no liability protection for its owner as is afforded to the shareholders of a corporation.

The biggest attraction to sole proprietorships is their simplicity. As long as you operate under your own name and don’t operate in a restricted field (selling tobacco or driving a taxi just to name a few and there really are very few restricted fields), you normally don’t even have to register your business with your provincial business registrar. However, if you want to use a name for your business other than your own name, you are supposed to register the business with your provincial business registrar which costs around $40 a year. This registration consists of filing some relatively simple forms declaring who owns the business (you), its address, its business activities (i.e. restaurant, building management, manufacturing, etc.) and the name under which it operates.

If you are starting out, sole proprietorships are generally the business structure of choice in Canada as there are few formalities or setup costs.

Sole proprietorships also allow you to declare any business losses on your own personal tax returns, so to say, the government is effectively subsidizing the risk associated with starting your business since it is reducing your tax burden by allowing you to offset your taxable income with your business’s losses.

That being said, as your business gets larger and takes on more risk, sole proprietorships become less attractive since if the business folds, you, as owner, are personally responsible for the business’s debts and contracts since, once again, everything the business contracted for is, in fact, something which you, its owner, personally contracted for. This is where corporations are more attractive since for them, there is a legal separation between the business and its owner, which means that the business’s owner is not personally responsible for the business’s debts.

From a tax perspective, as your sole proprietorship grows, it also becomes less attractive since you have to pay personal income tax on the business’s profits which is normally substantially higher than the corporate tax rate. This means not only do you have to pay more tax, but this leaves you with less of your profits to reinvest in your business. It’s at this point that it generally makes sense to convert your sole proprietorship into a corporation. I should also mention that businesses generally need to charge sales tax once they are on track to have $30,000 or more of sales in a given year, so this is yet another reason to incorporate, in order to avoid having personal sales tax numbers.

General Partnerships

General partnerships are the default regime for a business with several owners (as opposed to sole proprietorships which have a single owner) and do not require any formalities to open. Coming back to the lemonade stand example, if two people open a lemonade stand outside, they are operating a general partnership.

The default ownership structure for general partnerships is that everyone is an equal partner/owner of the business. In addition, same as for sole proprietorships, general partnerships do not create a separation between the business and its partners, rather the business acts through those partners.

Same as for sole proprietorships, the profits or losses of the business are declared directly onto each of the partners’ personal income tax returns. This is quite advantageous if the business is running a loss, but less advantageous if it’s making profits since, once again, the personal income tax rate is generally higher than the corporate tax rate.

Even though general partnerships are the default business structure for businesses with more than one owner and so no formalities are required to create such a business, it is highly recommended for the partners to have a contract to govern their partnership. In particular, that contract should cover, at a minimum, each partner’s partnership interest (ownership percentage of the partnership) and the expectations regarding each partner’s role and contribution to the business both initially and on an ongoing basis.

Same as for corporations, some of the biggest issues partnerships face is what happens if a partner wants to leave the partnership or to sell his or her partnership interest, and what happens if there is a cash call (obligation to inject cash in the business) and not everyone contributes. If a partner leaves the partnership and sells his or her stake in the business, the other partners are suddenly exposed to having a new partner who they do not want or even get along with join the business. Businesses are like romantic relationships, you need to pick your partners wisely or all hell breaks loose. For cash calls, the question is what percentage of the needed cash will each partner have to contribute and what happens to a partner’s partnership interest if he or she cannot or doesn’t want to put in the requested cash.

In a corporation, these issues are normally dealt with through a shareholders agreement. In a general partnership, these issues should be addressed through a partnership agreement. Definitely take the time to prepare such an agreement. It’s best to do it through a lawyer, but if that is not feasible, write up the main points and then have all the partners sign it (with each of the partners getting a copy of the signed version). As I wrote previously in KISS your Contracts (Goodbye), it’s better to have an imperfect written agreement that no written agreement at all.

Corporations

Corporations, also known as companies, are the most common type of business structure in Canada and for good reason. A corporation is a legal entity which is distinct from its members (shareholders, directors, officers and employees.) It can contract in its own name and, in most circumstances, if the corporation breaches a contract or commits a fault, the liability is isolated to the corporation without personal liability for its members.

If one imagines a classic business in Canada, it is likely corporation. A corporation allows for one or more people to own a business, while shielding them from personal liability, and the business’s profits are taxed at the corporate tax rate which is generally significantly lower than the personal income tax rate.

A corporation needs to be “incorporated”, so to say, it needs to be legally created and registered with the relevant authorities. Like anything else, building off of a strong base increases the chances of success. In this regard, consult a lawyer to help you to set up the corporation. At current rates, incorporations cost around $2,000. This should include a name search (to see if your business’s name is available), the business’s registration, the creation of the business’s share structure and preparation of a minute book and initial resolutions.

I should also mention that a corporation is incorporated either pursuant to a federal statute (i.e. the Canada Business Corporations Act) or a provincial statute (i.e. the Quebec Business Corporations Act). There are minimal differences between both types of incorporations and, when in doubt, go for a federal incorporation even though it is a little more expensive. To find out more about how to decide between a federal or a provincial incorporation, take a moment to read Federal or Provincial Incorporation: How to Choose.

Corporations also have to file annual returns to the relevant authorities (to the provincial business registrar for provincial corporations and to both the provincial and federal business registrars for federal corporations). Corporations also have to file corporate tax returns each year. This naturally adds to the annual maintenance cost of a corporation.

As an aside, if there are several shareholders of the corporation, it’s a good idea to have a shareholders agreement. A shareholders agreement is a contract which governs the management of the corporation, how certain decisions are taken, how and in what context share sales or transfers can occur, and what are the expectations for each shareholder’s participation and contribution in the business.

Limited partnerships

Limited partnerships are a cross between a corporation and a general partnership. A limited partnership has two types of partners: general partners and limited partners. The general partners run the business and take the most important business decisions. The limited partners have but limited (if any) involvement in the management of the business and are normally passive investors. General partners (same as the partners in a general partnership) are personally liable for the business’s liabilities whereas limited partners (same as shareholders of a corporation) have no such liability.

Limited partnerships are often used for high-risk investment vehicles and businesses since the losses of the business receive better tax treatment and can be used by some of the partners to offset some of their other income. A classic example of a limited partnership is a mining exploration business.

However, probably the most common usage of limited partnership is a limited liability partnership which is often the business structure used by professionals such as lawyers and accountants. This type of limited partnership has each professional fully liable for his or her own conduct while shielding the other partners from liability from such conduct.

Due to their complexity, limited partnership should only be considered as a business structure upon having received legal and accounting advice to this effect. When in doubt, a corporation should be preferred to a limited partnership. If you want to set up a limited partnership, working with a lawyers is a must.

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Now that you know the classic business structures in Canada, best of luck choosing your business’s structure. As always, if you have any questions or want help setting up your business, feel free to reach out. Enjoy!