Starting a business is an exciting process. You need to find clients/customers, develop your product, and figure out finances. One of the few things new entrepreneurs get confused about is whether to incorporate or how a sole proprietorship or partnership changes the status of their business.
In this article, we clarify what exactly it means to be in a sole proprietorship, a partnership, or to incorporate your business. There are different legal and tax ramifications for each that may impact you. This article is just the first step in learning about these three structures. Make sure to consult a lawyer and accountant for a true picture.
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1. Sole proprietorship
A sole proprietorship is an unincorporated business where you are the only owner. As the sole owner of the business, you have the power to make all decisions, receive all profits, claim all losses, and be responsible for any liabilities. This means that claims (legal or otherwise) against your business are claims against you and your personal property.
This enterprise structure is the simplest among the three. Registration is usually only required if you run the business in a name besides your own. And if you do use a different name, you also need a separate bank account under that business’ name in addition to an HST/GST number, depending on what your business does.
The biggest issues about a sole proprietorship is the opportunity for liability and the inability to scale. The potential for having a claim against you can prevent your business from making certain moves. For example, although you can hire as many employees as you want as a sole proprietor, each additional employee increases the likeliness that something could go wrong and, thus, increases the likelihood of a lawsuit. Another issue is securing capital. As a sole proprietor, others can’t make an investment in your business and the only way of securing additional capital is through debt.
2. General partnership
A partnership automatically occurs when two or more people carry on a business with a view to profit. No contract is required, but it’s always recommended that partners have a shareholders’ agreement in place. A shareholders’ agreement can determine how decisions are made, what happens when the partnership is sued or dissolved, and much more.
Similar to a sole proprietorship, a partnership doesn’t require any form of registration. It’s simple to set up and usually only requires filing papers if you decide to use a name besides yours and your partners’. This enterprise structure also requires a separate bank account in most cases and a GST/HST number, again, depending on the line of business.
A partnership is beneficial over a sole proprietorship because it can attract more capital to help grow the business. A partnership has no limit on the number of partners it can have. But any person who becomes a partner is — similar to a sole proprietor — on the hook for any lawsuit or claim against the business. With these benefits, partnerships become more complex than sole proprietorships and may require more legal and accounting help too.
A corporation is independent of its owners. It’s a legally established business that has to be incorporated and can have its own assets and debts. There are many pros of incorporation. It’s much easier to deduct expenses, liability is limited, and a corporation can live on indefinitely — unlike a sole proprietorship or partnership which dies after an owner leaves.
Corporations are more scalable than other enterprise structures. In a corporation, investors can put in money and only be liable for what they put in, making investments more viable. The limit on liability means a corporation can take on more risks like hiring a large number of employees.
But with great benefits come more responsibilities. Incorporation and the maintenance of a corporation require plenty of paperwork. When developing the foundation of your incorporated business, it’s best to seek help from a lawyer and accountant. These professionals can help with deciding whether to incorporate federally or provincially, filing corporate taxes—which differs from personal taxes—and more.
As you move from a sole proprietorship to a partnership to a corporation, the operation of your enterprise structure gets more complicated with shareholder agreements and incorporation papers. However, the benefits of a more complex structure allow your business to scale and grow.
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