The 3 Structures of Business

Which One is Right For You?

9 mins read

This article discusses in brief the 3 types of businesses out there and explains what makes each business type unique.

If you are considering starting a company or building a business, it is essential that you select the business structure that supports your goals the most. Often a business structure is selected to best take advantage of tax law, which can treat each structure differently, but there are also many other reasons for each option.

The 3 types of legal structures of business are, a sole proprietorship, a partnership (which is a form of proprietorship) and a corporation, and each one has distinct characteristics.

1. Sole Proprietorship

A sole proprietorship is a business with one owner and is the simplest structure to create. It is by far the most common structure chosen by new businesses. In this structure the owner is personally liable for all the debts of the business and pays personal income tax on the net taxable income generated by the business. Tax law treats this structure as an income source for the proprietor and thus requires that the business’s financials be part of the owner’s personal income tax form.

The most important fact to note here is that in a sole proprietorship the businesses money, debts, and responsibilities all belong to the proprietor and they are legally liable for everything that occurs in the business.

This can be both beneficial and detrimental. On a positive note, this structure allows for many tax advantages based on what is written off personally to run the business which can cause the operation to generate a loss. This can then be applied to reduce income gained from other sources and become a tax break against your net income. The low net income means that you would essentially pay less tax because of the losses taken from your business. That is why sole proprietorships are popular, the tax advantages. Unfortunately, being personally liable for every debt and everything the business does can become a very unbalanced lifestyle, with personal credit being flexed as the business grows and not much insurance against any swings in the market. If your business fails, the incidence of bankruptcy is very real. This has proven true for many businesses dealing with COVID currently because they didn’t pay into unemployment insurance and are unable to access some forms of COVID relief financing.

2. Partnership

A partnership is similar to a sole proprietorship except instead of a single proprietor there are two or more. There are many advantages to this structure in regards to the joint liability of a partnership in comparison to a sole proprietorship. But just like with a sole proprietorship there is no set legal structure for a partnership. It is usually based on an agreement that is made between the partners in a percentage of ownership, sharing of revenues, expenses and duties.

A partnership is treated the same way in the owner’s taxes, with the partners applying their same ownership percentages from their contract in the write-offs, income and expenses on their personal tax forms.

3. Corporation

Incorporation is a process in which a legal separate entity, owned by its shareholders, is formed.

Incorporation is used to create formal ownership, “shares,” which produces a legal distance and separate taxation between the company and the shareholders. This can then have tax advantages for the owners because they can become paid employees of the corporation.

Incorporation also provides liability protection that neither of the other structures offer. This includes the corporation’s debts and any legal obligations that could be held against the owners offering a measure of protection under the banner of the company’s name. Management, employees and shareholders may come and go but the corporation will continue until it is dissolved. This is especially attractive for legacy businesses who want to hand the business down within a family.

Many businesses that incorporate do so through a charter in their home province, but if that business is considering operating in several provinces or internationally it is to their benefit to incorporate federally. This may be more costly and complicated, but it also creates more credibility to the operation and its growth potential.

A corporation will also require extremely rigid bookkeeping and accounting because the business will need to report its financials yearly to shareholders and must always be open and prepared for being audited by chartered accountants. This may sound intimidating, but with the right processes in action it becomes just like clockwork.

Many businesses that incorporate do so through a charter in their home province, but if that business is considering operating in several provinces or internationally it is to their benefit to incorporate federally. This may be more costly and complicated, but it also creates more credibility to the operation and its growth potential.

A corporation will also require extremely rigid bookkeeping and accounting because the business will need to report its financials yearly to shareholders and must always be open and prepared for being audited by chartered accountants. This may sound intimidating, but with the right processes in action it becomes just like clockwork.

So, What is Your Best Option?

Popular and simple, both sole-proprietorship and partnerships are easy systems to set up your business with. You won’t need much accounting background and it can be a great way to use write-offs to benefit your personal tax return. But the liability that is carried with both structures can often be a make or break for your personal life with far more risk than incorporating.

Incorporation sounds difficult.

It may actually be a lot simpler and less expensive than you think, with many unrealized benefits. If the company structure is kept simple and you get some outside advice setting it up, you can be in business in less than an hour for very little cost. In fact, The Government of Canada website offers a walkthrough where you can apply directly through them to incorporate.

4 Steps to Incorporate

    1. Choose a corporation name and register it (see our articles on Choosing a Name for Your Business and Registering Your Business Name)
    2. Create your articles of incorporation – Basic articles can be modified later if necessary
    3. Establish the initial address and Board of Directors. Select a mailing address where all documents will be received (they will be legally assumed they have arrived to the organization) and who will sit on your Board of Directors
    4. Pay the Corporations Canada fees

We wish you luck with your new business venture and if you have any questions or need any help please don’t hesitate to reach out to BIG and our associates will assist you.

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