Legal Structure for a Canadian Business

One of the first questions you will face when launching a new business in Canada is, what legal structure should be used? Each of the options has good features and not-so-good features which you need to know about before making your decision.

There are four basic types of legal structure for businesses in Canada:

  1. Sole proprietorships
  2. Partnerships
  3. Corporations
  4. Co-operatives

Summarized below are the features of each type of business structure, together with indications of the positive and negative aspects of each. Deciding which form of structure to use for your new business may be simple (i.e. a sole proprietorship for a part-time, home-based business which you will operate alone), or it may be complicated (i.e. a business involving one or more employees will raise issues of liability, control, access to capital, and complexity of record keeping).

A Note on Taxes

We mention in the summaries below that various structures may offer some tax advantages. What these advantages may be will vary with the legal structure you choose for your business and with changes in the Canada Revenue Agency rules.

Sole Proprietorships

Sole proprietorships are the simplest kind of business to set up. If the business is established in the name of the proprietor without adding any other words, it is not necessary to register the business.

This kind of business is regulated by the provinces and if you choose to carry on the business under a name other than your own, you must register with the province (except in Newfoundland and Labrador where only incorporated businesses are required to register with the Provincial Registry of Companies and Deeds).

Advantages

  • startup costs are low and little working capital is required
  • least amount of regulation/red tape
  • you make all decisions
  • there are some tax advantages
  • all profits are yours

Disadvantages

  • your liability is unlimited and you are fully responsible for all debts and obligations of the business, so creditors have a right of claim against all your business and your personal assets
  • borrowing money for the business is difficult
  • the business will only operate if you are present

Sole proprietorships are often the way individuals start home-based businesses, converting them to one of the other legal structures when the business shows signs of succeeding.

Partnerships

Two or more people combining their skills and resources to start a business often form a partnership by signing a partnership agreement (sometimes known as a “shareholders agreement”).

General Partnerships

In a general partnership, all partners share in the management of the business and each partner is personally liable for all the debts and obligations of the business. Because each partner is liable, it is essential that you trust your partner(s) because you must assume the consequences of any decisions your partner(s) make.

It is important to realize that a partnership, like a marriage, should not be entered into lightly. Partners have wide apparent authority to personally bind the other partners.

Note, however, that a partnership agreement only governs the relationship between the partners, and limitations on a partner’s actual authority will probably not affect dealings with third parties who have no knowledge of the terms of the partnership agreement. Nonetheless, there is great value in spelling out the relationship between the partners.

Limited Partnership

In a limited partnership, some partners control and manage the business (general partners) while others contribute only capital and take no part in control or management (limited partners). Limited partners are only responsible for a specified (limited) portion of the debts of the business, while general partners are fully liable for all debt. In this arrangement, general partners are normally given a larger share of the profits.

The partnership agreement form supplied with this kit is for a general partnership. If you are contemplating forming a limited partnership, we recommend you seek legal advice as the agreement document can be quite complex.

Like proprietorships, partnerships are regulated by the provinces and you must register with the province (except in Newfoundland and Labrador where only incorporated businesses are required to register with the Provincial Registry of Companies and Deeds).

Advantages

  • startup costs are quite low and partners can share in supplying working capital
  • limited amount of regulation/red tape
  • easy to form a partnership
  • some tax advantages
  • partners’ joint knowledge can benefit management decisions

Disadvantages

  • liability is unlimited
  • borrowing money for the business is difficult
  • conflict between partners is a serious risk
  • typically, no one person has complete and final authority to act
  • suitable, compatible partners can be hard to find

Partnerships are often the way friends start small businesses, pooling their skills and knowledge. Successful partnerships usually incorporate when the business shows signs of succeeding.

Corporations

Unlike a proprietorship or a partnership, a corporation is a legal entity that is separate from its owners. The owners (shareholders) of a corporation are not personally liable for the acts, obligations, or debts of the corporation.

There are different kinds of corporations:

Private Corporations

  • formed by one or more people
  • cannot sell securities or shares to the public
  • a majority of the directors must be Canadian residents
  • if none of the directors reside in the province in which the corporation does business, the corporation must appoint a Power of Attorney who resides in the province

Public Corporations

  • issue securities for public distribution
  • must distribute semi-annual financial statements
  • must employ outside auditors
  • must file a prospectus with the appropriate Securities Commission in the province

Federal Corporations

A business operating nationally or in several provinces may find it useful to incorporate federally under the Canada Corporations Act. Both private and public corporations can incorporate federally.

Be aware that a federally incorporated business must still register in each province in which it does business.

Advantages

  • limited liability
  • tax advantages
  • easier to raise capital
  • ownership can be transferred by selling shares
  • ownership and management may be different

Disadvantages

  • expensive to organize and closely regulated
  • extensive recording keeping is a requirement
  • dividends are double-taxed
  • some charter restrictions
Co-operatives

A co-operative is a form of corporation which is organized and controlled by its members in a co-operative business structure. The business structure involves open and voluntary membership with control based on one member, one vote. Co-operatives are usually formed by members to provide themselves and their patrons with goods, services, or other benefits through a pooling of resources.

Advantages

  • limited liability
  • owned and controlled by members
  • profits (any surplus earnings) distributed to members in shares or cash in proportion to their use of service

Disadvantages

  • decision-making process can be long
  • members must participate for the venture to succeed
  • one member, one vote reduces incentive to invest additional capital
  • extensive recording keeping is a requirement
  • risk of conflict developing between members

The legal form your new company takes brings advantages and disadvantages no matter which form you choose. The more a legal structure protects you and your personal assets from the risks of the business, for example, the greater the paperwork load you will incur. If in doubt, talk to your accountant or financial advisor.

About business-startup-kit-large The article above is an excerpt from the Business Startup Kit on CD-ROM from Self-Counsel Press.

The kit contains instructions, checklists, forms and more to help you through the planning stage to the launch your new business.

Click on the image on the left to enlarge it. Learn more about it here.

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