3 Types of Business Structures

July 9th, 2020 post featured image

There are many financial planning decisions business owners make, whether you are already an owner or thinking of becoming one.

Many of these decisions will not only impact your business but also your family’s financial wellness. Structuring your business is one of the first decisions you will make. Even though you can change your structure in the future as your business grows or new owners join the team, it can be more cost effective to anticipate your needs and select the structure to best meet those needs. The legal structure will guide decisions and should be chosen based on your business goals. Each structure has its advantages and disadvantages.

It is important to get proper legal and tax advice when determining how to structure your business. Your decision should take into account a range of factors including:

  • the nature of your business
  • where you are located
  • the number of owners and employees
  • tax considerations
  • potential exposure to liability
  • start-up costs or financial requirements
  • transition or exit options

The three most common types of business structures are: sole proprietor, partnership and incorporation. Depending on the number of owners in a business, options will vary. For example, if there are one or more owners, your options are either partnership or incorporation.

  1. Sole proprietorship is the most common and simplest structure. It allows the owner to have total control over company operations. You are considered self-employed and can hire employees; you manage the business yourself. The owner receives all the profits, claims all losses, and does not have separate legal status from the business. Some advantages of sole proprietorship are: it is less costly to set up, you have full control over your business and you earn all the profits. A disadvantage to being a sole proprietor is that you also assume all the risk of the business and this risk can extend to your personal assets. When it comes to selling our business, ownership cannot be transferred only the assets of the business can be sold.
  2. A partnership is formed when two or more people join, or partner, together to run a business. Each partner has equal share in the net profits and losses of the business. Each partner contributes money, labour, property, or skills to the partnership. In return, each partner is entitled to a share of the profits or losses of the business. The business profits (or losses) are usually divided among the partners based on the partnership agreement. Advantages of this structure are: it is easy to form, you have a shared responsibility for the debts and profits in the business as well as different skill sets that can enhance your business operations. The potential cons of a partnership are: you are still personally liable for the debts of the business, finding a partner you are compatible with can be hard and there can be conflicts that arise from difference of opinions. Ownership generally cannot be transferred in a partnership unless a limited partnership is formed where shares could potentially be transferred.
  3. A corporation is an option whether you are just starting out, are already a sole proprietor or in a partnership. This structure is more expensive and complicated to set up and manage but provides advantages over the other two structures.

A corporation is treated as a separate legal person under the law with a certain number of shares that you determine. Shares are allocated which establishes the ownership structure – it can be one shareholder or more. Shares can be issued or bought and sold and can provide a way of raising capital unlike sole proprietorship and partnership structures which rely on the capital supplied by their owners. Other advantages of a corporation include keeping your personal and corporate assets separate as well as tax advantages such as choosing when to take income and which type – salary or dividends, possible tax deferral or credits and the capital gains exemption when sold. Corporations can live on despite transferring ownership so it can be easier to sell or pass on a business. Possible disadvantages are: it is more costly to establish and manage, there are no personal tax credits as well as owners may have to personally guarantee financing.

Your professional advisors can help ensure you are well informed on the legal and taxation issues you may encounter so you understand the personal and business implications of each business structure. Planning ahead to protect your business and the ones you love, will help you achieve long term financial success. If you own a business and would like to talk to one of our advisors about your business structure or plan, please connect with us.