How to choose the right legal structure for your business and what they mean Part 1: Corporations

Types of legal structure

One of your first considerations when starting a business is the form of legal structure with which to operate the business.  This will be necessary before you set up a company bank account, apply for a business license, register for coverage under the workplace safety and insurance board or apply for your Revenue Canada business number.

The type of legal structure you decide on for your business depends on several factors including your potential risk and liability, your financing options, the degree of your participation in management, and tax implications.  If your potential risk and liability is high, the incorporation process will provide protection from possible disasters.  On the other hand, a person starting a business with little or no risk should consider the advantages of having a sole proprietorship.  Once you become familiar with the differences between each form of legal structure, you should consult a lawyer and tax accountant.  Your decision in this area is an important one.  Your main options will include: corporations, sole proprietorships and partnerships.

This is a three-part article that will explore the three types of legal structures you should consider before starting up a business in Canada.

Corporations (Limited Company)

The corporation is the most common form of business organization and, despite common belief, it is not restricted to large organizations.  Corporations come in all sizes.  A corporation is a business that is a legal entity separate from the owner or owners of the business. Shareholders and management have separate legal personalities from the corporation and are therefore subject only to limited liability.

A corporation is a formal business structure that, after being incorporated with the provincial or federal registry, must file annual reports, submit regular tax returns, and pay tax on the profits of the business.  The shareholders elect directors who are responsible for managing the business affairs of the corporation.  Directors are usually shareholders.  The profits of the corporation may be retained for re-investment or, at the discretion of the directors, distributed to the shareholders in the form of dividends.  A corporation can carry on business, own property and is subject to all legal and contractual obligations in the same manner as any individual.

Although it is possible to incorporate a company without the benefit of legal advice it is advisable to obtain legal and tax advice to assist with the preparation of the incorporation documents and shareholders agreements.

Advantages

Limited liability. The shareholders are not personally responsible for any of the debts or obligations of the corporation, unless a shareholder has signed a personal guarantee.

Raising capital. Raising of capital is easier because of financing flexibility.  A corporation can attract investors and provide better security to lenders in the form of debentures, common shares, convertible shares and other structures.  The corporations my also be eligible for government financing incentive programs that may be unavailable to unincorporated businesses.

Perpetual existence.  The corporation’s existence has the potential to be perpetual because the departure or death of any or all of its shareholders or managers will not affect it.

Possible tax advantages.

Transferrable ownership.

Disadvantages

Corporations are closely regulated by a legislative scheme.

Costs of incorporating are higher, but this monetary outlay should be kept in perspective.  It is simply another cost of doing business if the reasons for incorporating a business for tax or liability benefits are appropriate.

Onerous requirements of shareholder and regulatory financial reporting.

The operating losses and tax credits remain within the corporate entity; they are not available to individual shareholders if the corporation is unable to utilize them.