The business structure of an enterprise is the key factor in determining its success and growth. It provides guidance and clarity as in which direction the business will move. In the absence of a good structure, the business can lose track and fail to pay off its debt and obligations.
Your choice of business structure can have a major impact on your enterprise’s legal entity, tax exposure and managerial authority. Each business structure has a different effect on how much you earn from the business, the tax amount you have to pay out of the business profits, whether your personal property is protected, or whether you can invite partners/ investors into the business.
Generally, there are four types of business structures in Canada: sole proprietorship, partnership, corporation and cooperative. Each structure has its own features, pros and cons. If you have started a new business or are planning to start one, you should know each structure type to best select the most suitable option for you.
Here’s an overview of the different types of business structures along with their pros and cons to help you choose the perfect one for your enterprise.
Sole proprietorship is the simplest and least expensive way of starting a business. It is owned and operated by one person, but you can hire employees to assist. It has less paperwork and offers more control over the business. It does not require huge initial costs, you will get the profit and you will be responsible for all debts. According to the law, you and your business are considered as one.
• Minimal working capital is needed to start a sole proprietorship business
• Registration is quick and easy
• No federal permit is required to hire employees
• The power of decision-making is solely on the owner, leading to quicker decisions
• No separate business bank account is needed. However, it is recommended for bookkeeping and audit protection
• All business profits are considered as your personal income reported on your Schedule C (Form 1040)
• Eligible for ‘pass-through’ taxation where the business itself is not taxed separately. The taxes are charged on the owner’s income.
• The owner is accountable for all the liabilities of the business
• Raising capital is difficult as the business is owned by one person
• As the business and the owner are considered one entity, the owner’s assets can be used to pay off the debts of the business
• The net income generated by the business is considered as the personal income of the owner. So, if the profit is too high, the owner is liable to pay income tax on that amount
• The death of the owner can result in the termination of the business
A sole proprietorship structure is suitable for businesses where the market for the product is small and local. If you’re targeting local customers, the budget is limited, and you don’t want to take the risk, then a sole proprietorship model is an ideal choice for you. For example, if you plan to run a garment shop, grocery store, jewellery making business, etc.
A business owned by two or more individuals is called a partnership business. In this structure, the owners combine their resources into the business, the profits are divided among the partners and all the partners are liable for the debts of the business. However, it’s not necessary that they share profits and losses equally. The profit and loss sharing ratio is in accordance with the partnership agreement made between the owners when the business is formed. Like a sole proprietorship, in this business structure, a partnership is not considered a separate legal entity from its owners.
There are two types of partnership, general partnership, and limited partnership. General partnership is where all partners have control over the management and are liable for the debts of the company. Limited partnership is where all partners don’t have equal powers. Some partners are responsible for managing the company whereas others contribute financially, and the profit sharing also varies.
• Easy and inexpensive to establish
• Less paperwork is involved
• Keeping track of cash flow, income and expenses is relatively simple
• Additional sources are available for investing capital
• Eligible for ‘pass-through’ taxation where income is declared on the partner’s returns
• In the case of a general partnership, every partner is actively involved, and a centralized management structure is followed
• In a general partnership, the partner’s personal assets are exposed because they’ll be held responsible for the debts of the company
• Raising capital further can be difficult
• Lacks continuity as a conflict between partners can create problems in the business
• The actions of some partners can affect others and have a negative impact on the business
• Finding suitable partners can be difficult
• Authority is divided between partners, thus leading to a slow decision-making process
A partnership structure is ideal for businesses where the initial capital requirement is moderate, and the owner is in contact with persons having different resources and expertise who can contribute to the business as per their specialization. Some suitable businesses for partnership model are legal firms, construction businesses, and wholesale trade.
A business structure that has a separate legal entity from its owners or shareholders is called a corporation. It is also known as a limited company as the liabilities of the owners are limited to the value of their investments. Since the company is a distinct entity, it can acquire assets, pay its debts, enter into contracts and sue or it can be sued. It has an unlimited life expectancy and can be continued after the owner’s death as ownership can be transferred, unlike sole proprietorship and partnership. A corporation can be incorporated at the provincial or federal level. If you want to operate solely in one province, provincial incorporation is the best choice whereas if you want to extend your company’s area of operation to other provinces or outside the country, then a federal incorporation will be the best bet.
Generally, there are two types of corporations, private and public. A private corporation can be formed by one or more people, but the majority of its directors must be residing in Canada. The shares and securities of a private corporation are available for sale to the public. On the other hand, a public corporation is a company that can sell its shares or securities to the public by listing a class of its shares in the stock exchange.
• Liability is limited to the value of the contribution. As a result, the owners cannot be held liable for the corporate debts and obligations
• Raising capital is easy by selling the shares to the public (in public corporation)
• Continuous existence is ensured as ownership of the company can be transferred after the death of the owner
• The owner draws a salary and income tax is paid on the personal income
• Owners are protected from the lawsuits filed against the business as they are separate legal entities
• Lenders consider corporations to be more credible due to its continued existence
• The initial setup cost is greater compared to other business structures
• Higher maintenance costs as the cost of filing corporation tax returns and business bank account charges are expensive
• Maintenance of financial statements and other record keeping is extensive
• Regulatory demands are more complex and serious
• No personal tax credit is applicable, unlike sole proprietorship and partnership
A corporation model is suitable for enterprises where the volume of business is large and you need huge financial resources to incorporate. If you’re willing to take heavy risks and have good public support and confidence, then a corporation will be the best choice for you. Pharmaceuticals, aluminum, iron and steel and information technology are some of the businesses suitable for this business archetype.
A cooperative is a slightly different business structure from other conventional models. It is a type of business where people work together willingly for a common purpose or benefit. The business is democratically owned by the people who work in it. Each member becomes a part of the business voluntarily and has an equal say in the business operation, thus giving them real control over the enterprise. The profits are divided on the basis of how much a member uses the organization, instead of how many shares they hold.
Broadly speaking, there are four types of cooperatives, worker cooperatives, consumer cooperatives, producer cooperatives and market stakeholder cooperatives. In a worker cooperative, the business is owned and self-managed by the employees. The purpose of this business is to provide employment for its members. A consumer cooperative is the one where products or services are provided to its members. The purpose of this business is to provide services rather than making a profit. These businesses are mostly in the form of retail stores. In a producer cooperative, the business is owned by the producers who produce and market goods and services of similar nature. It could be a group of farmers, artisans, independent entrepreneurs, etc. A multi-stakeholder cooperative is the one that serves the needs of different shareholders or stakeholders such as clients, employees or other organizations. It is governed by two or more stakeholder groups and each group has a specific role, but a common goal.
• Decision-making process is fair as each member has an equal democratic say
• More communicative workplace
• Members of the cooperatives get various economic benefits depending upon the type of cooperative
• Fewer incentives for big investors as a greater contribution in a cooperative does not mean greater shares
• Raising capital could be difficult
• No tax relaxation as cooperatives pay the same taxes as other corporations
• Decision-making process is slow because the power is decentralized
• No edge over the competition
• No control over the direction of the business
If you know a lot of people in your industry who have a common goal, are willing to work for it and your motive is not solely to make a profit, then a cooperative is the best bet for you. Make sure that you are backed by a grant from the local development funds to maximize your efforts.
Each business structure has different characteristics. Go through the features, advantages, and disadvantages of each model and decide which one works best for you. Choosing the right business structure is essential to ensure business growth. After all, your choice of model can affect your ability to raise finance, tax regulations, control over business and personal liabilities.
Remember, whichever structure you choose, you need to maintain its finances properly. From recording all the transactions in the books of accounts to managing invoices, every financial information must be error-free to avoid problems in future. If you need assistance in handling your finances, you can contact Virtuous Bookkeeping, the one-stop solution for all your bookkeeping needs. Call us at 1-888-807-5009 to request a quote.
The Virtuous Bookkeeping explores ways for entrepreneurs to enjoy independence and better run their business. Join over 10,000 subscribers and get our best articles delivered via email.