There are many benefits to incorporating a business. Incorporation can provide protection from liability, tax benefits, name protection and flexibility for its owners, among other things. That doesn’t mean that it’s right for every business or situation. There are times when incorporating won’t make sense due to the size of the business, the owner’s financial means
The most common alternatives to incorporating a business in Canada are operating as a sole proprietor or a partnership. Let’s take a look at these options in more detail:
The Sole Proprietor
The first and most common alternative to incorporating is to operate the business as a sole proprietor. Being a sole proprietor means that you’re in business for yourself. Although technically you can hire employees, most sole proprietors work alone. They are the sole owner and operator of the business. Money made by the business goes directly into the owner’s personal bank account. It’s also taxed at their personal tax rate.
What are the benefits of operating a business as a sole proprietor?
- Operating as a sole proprietor is usually the cheapest to set up and easiest to maintain
- A sole proprietor business generally has less ongoing administrative work than other forms of business ownership;
- Because sole proprietors are the business, they have direct control over decision making;
- There is no need to declare dividends or pay the owner a wage.
What are the downsides of o
perating a business as a sole proprietor?
- Sole proprietors have unlimited personal liability. If the business has problems, the assets of the owner are at risk;
- You cannot share ownership of a sole proprietor business. This greatly reduces flexibility in terms of investment, splitting of income, business succession and transition of ownership;
- Income of a sole proprietor is taxable at the personal rate which could place them in a higher tax bracket;
- When operating as a sole proprietor, it can be more difficult to claim business expenses for tax purposes;
- Sole proprietors have limited options when it comes to branding their businesses. They can use a trade name, but this can be awkward to use in practice. It also provides less protection than a corporate name;
- Sole proprietors are often considered less credible in the eyes of the public;
- Sole proprietors have limited options when it comes time to sell or transfer the business. Their only option is to sell the assets and transfer accounts, contracts, etc. to the new owner. They cannot sell ownership of the business itself through a transfer of shares;
Although there are many disadvantages, it can still make sense for some business owners to operate as a sole proprietor. It’s the easiest and cheapest form of business. It also provides the least protection and flexibility for the business owners.
The second most common alternative to incorporating is to operate the business as a general partnership. This means that two or more people are working together in some way to make a profit.
In a general partnership, each partner is considered an agent of the partnership and of the other partners. This can make operating the shared business easier, but can also lead to problems.
What are the benefits of operating a business as a general partnership?
- A general partnership is very easy to set up and is relatively easy to maintain;
- The partners of a general partnership can enter into a partnership agreement setting out their respective rights and responsibilities. If done properly, this can limit some of the downsides discussed below;
- Decision making can be easy, as each partner can make decisions on behalf of the partnership as a whole;
- The partnership itself does not need to file a tax return.
What are the downsides of operating a business as a general partnership?
- Each partner has unlimited personal liability unless the partners themselves are corporations;
- Each partner is responsible for decisions made by the other partner. This can lead to unexpected liability, disputes
- It can be difficult to determine who owns what. For example, who owns the intellectual property created by the partnership? If the partners get into a dispute and need to end their relationship, who gets what?;
- Because each of the partners is taxed individually, operating through a partnership can result in higher taxes;
- Options for branding and name protection of a partnership are limited and provide less protection than a corporation;
- It can be difficult to transition a general partnership to new owners and to hire employees for the business.
Due to the lack of liability protection, unclear ownership, and the trust required between each of the partners, general partnerships are less common than businesses operated as a sole proprietor or corporation. Operating as a sole proprietor is usually a short term solution. It’s used while the business is small and the owner sees how the business is going to turn out. This is convenient but can make things much more complicated down the road.
How to Decide on the Right Form of Business Ownership
Deciding on the right form of business ownership can be difficult. Often times there isn’t a perfect answer to the question of which form is best. Operating as a sole proprietor or partnership may make sense today, but it might not in a year from now. If you decide to switch over to a corporation in the future, you’ll need to transfer over all of your business assets, contracts, employees, domain names, software licenses, cell phones, insurance, etc. to the corporation. This transfer may be a taxable event and is likely to cost you time and money. For these reasons, we strongly recommend taking a closer look at incorporating before choosing another option.
Some important factors to consider
It’s important to consider the alternatives to incorporating, however, if any of the following factors apply, you should seriously consider whether incorporation is more appropriate for your business:
- You intend to sell your business at some point in the future;
- You expect the business to generate over $50,000 per year;
- You want to have business partners;
- You intend to hire employees;
- You’re concerned about the protection of your personal assets;
- You’re concerned about the credibility of your business;
- You want to protect your brand identity;
- You expect the business to have more than one owner at some point;
- You want to split income with your spouse;
- You want to save money on taxes;
- You want the corporation to be able to raise money;
- You want to avoid having everything in your personal name.
Operating a business through a corporation will generally address the above issues and needs better than other available business models.
Make an informed decision
We strongly recommend that you speak with a lawyer before making a decision. A good lawyer won’t pressure you to incorporate. Instead, they’ll ask you questions to help determine if incorporating is right for you. They’ll also help you determine whether the potential benefits outweigh the cost of incorporation. If incorporation doesn’t make sense, they can also help you fully consider the alternatives to incorporating.
Click the Free Consultation button below to speak with an Alberta business lawyer about which type of business structure to choose.