Small Business Structure--the Canadian Way
I was approached by a client the other day with a question I
couldn't immediately answer. He has a small construction
business and was looking for a partner so he could win bigger
contracts, and he wondered how he should go about doing that. I
had to tell him I couldn't give him advice on structuring a
small business because I'm not a lawyer or an accountant, but I
knew I could give him information, so I started to research.
I knew from setting up my own company about the various
structures Canadian small businesses can use. I thought his
choices would be limited to sole proprietorship, partnership and
incorporation. There's also a co-operative, but that doesn't
apply to my client. I guessed that the best way to help him out
would be to define and give him the advantages and disadvantages
of each.
Sole proprietorships are owned by one individual, and are
legally considered an extension of yourself. That means that any
liability or obligation your business incurs is also a personal
liability or obligation. So, if your sole proprietorship fails,
your personal assets can be seized to pay for that liability of
obligation. I'd say that's a pretty big disadvantage. On the
plus side though, sole proprietorships are the easiest to set up
and, and don't even have to be registered if its name is exactly
the same as your own.
A partnership is an agreement between two or more persons to
carry on business together. Partnerships are a separate legal
entity from you, and must have at least one general partner. All
partners can be general, but there must be at least one general
partner. Partnerships are relatively easy to set up, but
although not a requirement, the parties should have a contract
between themselves outlining responsibilities and
obligations.
A general partner is responsible for business decisions, running
the company and acting on its behalf. Each general partner is
jointly and severally liable for partnership debts. This means
one partner can be held responsible for the decisions, debts and
obligations of another partner. Strike one against general
partnerships, I'd say.
So what about a limited partner then? Limited partners are not
involved in decision-making or in the day-to-day running of the
business. Usually, a limited partner's contribution is
financial, and their liability is limited to the amount they
invested in the firm. What that means is you basically have no
say over how the money you invested is used, which means you
have zero power. And, the moment a limited partner becomes
involved in running the business or acts on behalf of the
business, they become a general partner.
A corporation is a separate entity from yourself, which means
you don't have personal liability for debts, obligations or even
acts of the company. You're not personally responsible for any
decisions someone else in the corporation makes, and you're only
liable up to the amount of unpaid portion of shares you own.
Sounds pretty good so far.
Limited liability is a big advantage over other forms of small
business structure. And there are more advantages. Corporations
continue to exist after their shareholders die and can be passed
on to family or friends. Raising money is easier for a
corporation than either sole proprietorship or partnerships.
There can also be tax advantages.
So what are the disadvantages? Well, there's more paperwork
because you're required to keep records and you have to file a
separate tax return. It costs more to register a corporation
than setting up a sole proprietorship or a partnership. And, if
you give a personal guarantee, which banks often ask for, you
may be liable for that amount even if your company ceases to
exist.
I thought my client's choice would be limited to those three
choices, but further research showed I was wrong. There is
another one: joint venture. A joint venture is like a
partnership because it's an agreement between two or more people
or small businesses, but there are important differences. In a
joint venture, two or more people contribute goods, services or
capital to one business enterprise. To date, Canada does not
have specific laws governing joint ventures, as it does with all
the other small business forms.
A joint venture agreement outlines joint venture terms,
contributions of each party, management structure and how the
profits will be divided. Joint ventures avoid the partnership
disadvantage of joint and several liability, and also allows
each joint venturer to regulate their own tax deductions. That's
a big advantage for joint ventures.
However, a joint venture has sometimes been defined by the
absence of key partnership elements. This means small businesses
intending to enter into a joint venture agreement must
thoroughly understand partnership elements and avoid using them
in order to avoid being deemed a partnership rather than a joint
venture. What might have started out being a joint venture could
lose its joint venture advantage by being deemed a partnership,
and inherit the disadvantages of a partnership instead.
You can incorporate a joint venture, which would then have the
same advantages and disadvantages of any corporation. And it
would have the advantages and disadvantages of a joint venture.
Could this possibly be the best solution?
So, I showed all this information to my client last week. He was
glad to be able to understand all the differences, and wants to
make a decision by the end of the month. I wonder what his
decision will be. I know what I would do. Do you?