Three Business Structures You Need to Know Before Starting a Business

By Mydene Cuevas

When starting a business one of the first considerations an aspiring entrepreneur should ask herself is how to appropriately structure her new venture. The differences between sole proprietorships, partnerships and corporations are vast and can have a significant legal (and non-legal) impact on the business owner.

As a business lawyer, I often work with entrepreneurs at the outset of their ventures and assist them with finding the appropriate structure for their respective businesses. Some features of each type of business structure are as follows:

Sole Proprietorship

While a sole proprietorship is a convenient, easy and inexpensive way to start a business, one of the biggest disadvantages of this type of business structure is the unlimited liability of the owner. This means that a creditor can make a claim against the personal and business assets of the owner to satisfy debts. There are also tax implications, which could either be positive or negative, depending on the profitability of the business.

Partnership

A partnership is a non-incorporated business owned by two or more individuals. In a general partnership, the responsibilities, expenses and profits of the business are shared among the partners, who are jointly and severally liable for the debts of the partnership. In a limited partnership, the limited partner may contribute financially to the business but is not involved with its operations.

Similar to a sole proprietorship structure, the biggest advantages of a partnership is the ease and low cost of starting the business. As well, there may be tax advantages in this type of structure when the profits of the business are modest.

However, another similarity the partnership structure shares with that of a sole proprietorship is the exposure of the partners’ personal assets to liability. There is unlimited liability, and creditors of business debts can make a claim not only on the business assets of the partners, but also on their personal assets. Another disadvantage is that all partners are responsible for the decisions, even poor decisions, of one partner. For example, if one partner breaches an agreement, all partners are held liable for that breach.

When entering into a partnership, it is crucial to have a partnership agreement in place. An important term in a partnership agreement is a dispute mechanism that determines what can be done when a dispute occurs. This is vital even, or perhaps especially, when the partners involved are family members or close friends. At the outset of forming a partnership, the relationship between the partners is often amicable and collegial. However, these relationships may be strained with the pressures of operating a business.

Corporation

A corporation is a legal entity separate from the owners, or shareholders, of the company. When a business is incorporated, it acquires the powers of an individual: it can acquire assets, go into debt, enter into contracts, sue or be sued. One disadvantage of choosing this business structure is the considerably higher expense of forming it, compared to that of a sole proprietorship or partnership. The advantages of a corporation, however, are as follows: unlike a sole proprietorship or general partnership, the shareholders of the corporation have limited liability. A shareholder of the company is not usually personally liable for the debts, obligations or acts of the corporation beyond the amount of share capital the shareholder has subscribed. Secondly, the corporation enjoys perpetual existence; even when the shareholders pass away, the corporation continues. Thirdly, there may be possible tax advantages as taxes may be lower for an incorporated business, particularly when the profits of the business grow.

In a corporation, where there is more than one shareholder, consider whether a shareholders agreement is appropriate for your business. In the shareholders agreement, the founding shareholders determine how a company is owned and managed. It should address any rights of first refusal among shareholders; restrictions on transfer of shares; termination of the agreement. As well, consider the significance of having an exit mechanism in the contract where a shareholder may leave and get a return on his or her investment. One such mechanism is called the “shotgun” clause, which is often used as a force buyout, and works like this: Bob and Jane are the two shareholders in the corporation. Jane offers her share to Bob for a certain price. Bob may accept the offer, or, instead, offer the exact same terms to Jane, in which case Jane must accept. While the shotgun clause may be acceptable for certain small businesses, it is not appropriate for all companies. Please contact a business lawyer for more information.

Starting a small business is an exciting journey. There’s no better place to be than the Province of Alberta to start a business, as it leads the country in small business creation.[1] However, the journey to successful entrepreneurship is a long, and often arduous, one so start it off right by enlisting the help of the right professionals who can help you build a solid foundation for your business. Aside from a good accountant, talk to a business lawyer who can help you determine which business structure is the most appropriate for you, and how you can better safeguard your personal and business interests.

Mydene Cuevas, JD

Mydene is a business, corporate and commercial lawyer with Miles Davison LLP. As a former small business owner, she is passionate about assisting business owners through the many legal aspects of owning and operating a business – from incorporation through to the sale of the business and everything in between. She may be reached at mcuevas@milesdavison.com or (403)298-0334.

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[1] Retrieved October 12, 2016, from http://www.smallbusiness.alberta.ca/small-business-in-alberta/

* The content in this article is provided for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Please contact a lawyer if you have any questions or wish to obtain legal advice.