Some time ago, we presented you with a face-off between two legal forms for a business: the corporation and the general partnership. Today, we present another legal form, one of the most popular because of its simplicity: the sole proprietorship. Does this legal form allow you to do business in the same way as others? When should you register as a freelancer? What are the advantages of incorporation compared to sole proprietorship? All these questions will be discussed in this face to face between these two legal forms.
As in our article comparing incorporation to partnership, this face-off will be based primarily on the following five aspects: governmental procedures and fees, ease of decision, responsibility of the actor, tax treatment and finally longevity.
1. Governmental procedures and fees
Winner: the Sole Proprietorship
There is no doubt that the sole proprietorship is the easiest to set up. One of its strengths is its simplicity. Unlike a corporation, a sole proprietorship does not have a separate existence from the individual who runs it.
When you operate a sole proprietorship under a name other than your own (except for tanning salons and tobacco companies), you are required to register with the REQ. This is a simple, inexpensive online process that does not require the assistance of a lawyer. Your sole proprietorship is registered and allows you to carry on your business in Quebec in compliance with the law.
Incorporating and registering a corporation is a little more complicated. Indeed, the creation of a corporation requires that it be incorporated before it is registered. The incorporation of a legal person, also called company or inc., generates several legal obligations. It will be necessary to produce articles of incorporation, to which the appropriate schedules must be attached, as well as a minute book that must be kept up to date throughout the life of the company. As you will have understood, the administrative and legal formalities are much greater when one decides to incorporate, and often requires the assistance of a lawyer to make sure you have the necessary documents. Apart from the legal fees, the incorporation fees are also higher than those related to the registration of a sole proprietorship.
It is therefore undeniably easier to set up a sole proprietorship than a company. This legal form will allow you to start your business more quickly and at a lower cost.
2. Decision-making facility
Winner: Tie
In the same logic of things, the sole proprietorship has another advantage by the fact that it is operated by a natural person who takes all the decisions of the business without any additional formality. This facilitates the fluidity of the processes and the decision making and therefore makes the sole proprietorship, on the whole, a legal form that is much simpler to manage.
In comparison, the corporation is the best vehicle if you decide to start a business with someone else. Being incorporated will make it easier to work with your business partners, because everyone can be assigned a role in the project. We will then have shareholders, directors and officers, among others, who will work together in the best interests of the company. Obviously, if you are the sole shareholder and director of the company, things are easier, but it is common to bring in an additional director or shareholder when the company starts to grow. The board of directors is then involved in the decision making process, which must generally be done by a simple majority, and the whole process must be recorded in written resolutions of the board. The same applies to shareholders’ meetings, for example.
In other words, if the company is managed and owned by the same person, the decision making will be as simple as for a sole proprietorship. However, it is important to keep in mind that although the fact of operating a company with several people can be a considerable advantage that a sole proprietorship does not offer, you will not necessarily have the same autonomy in terms of decision-making as you would have when you are self-employed. The self-employed person assumes the burden of having to make all the business decisions alone, whereas the players in a company have the possibility of delegating certain decision-making aspects of their business to specialists in their field. These are things to consider before starting a business.
3. The actor’s liability
Winner: the Corporation
One of the main strengths of the company, which makes it the most popular legal form in business, is the limited liability of its stakeholders. What do we mean by this? As mentioned earlier, one of the major differences between our two legal forms is that the company requires the creation of a legal person. The control of this legal person is then done through shares held by those who are considered the “owners” of the company, and the decision making is done by the directors of the company. However, the debts contracted and the contracts made for the company are made in its name, and not in the name of the shareholders. This means that in the event of a breach of these obligations, it is the legal person, i.e. the company, that is held liable for them, and not the shareholders and directors. Obviously, this protection is not absolute and certain cases, such as fraud, will engage the liability of the directors at fault, but it remains a considerable asset that may become even more relevant in certain sectors of activity. Note also that this protection does not replace liability insurance, so it is important to find out about it before you start.
On the other hand, a sole proprietorship does not offer any liability protection. The patrimony of the business is not separated from that of the self-employed person, which means that all debts and contracts made for the business are made in the name of the self-employed person. In the event of a default or unsatisfied client, he or she will be held personally liable.
4. The fiscal treatment
Winner: the Corporation
To keep with the theme of the distinct legal personality of the company, let’s look at its fiscal aspects. In fact, the existence of a legal entity outside of its founders means a double tax declaration. What does this mean in concrete terms?
While a sole proprietorship is directly taxed according to the individual rate on all its business income, having a legal entity generating income immediately allows much more tax flexibility. In other words, as long as the income does not flow out of the company, whether it is paid to you as a salary or as dividends, for example, it is subject only to corporate tax, which is significantly lower than personal tax at a certain income level.
This is particularly interesting when your business income exceeds your personal financial needs to live on, since you can keep the extra income in the company, which will be taxed much lower, and reinvest it in the company, for example. Such tax flexibility is not possible in a sole proprietorship, since all your business income will be subject to the personal tax rate.
It becomes almost essential, after a certain level of growth of your business, to consider incorporation in order to avoid too many tax consequences on your activities. On this subject, the company has an undeniable advantage that must be taken into account, and consulting a specialist in the field such as a tax expert is generally very relevant.
5. Business growth opportunities
Winner: the Corporation
It is no coincidence that most of the large companies you know operate through corporations. Although sole proprietorship is a suitable form of business start-up because of the ease of its creation, it has its limits in terms of growth. The advantages of the company in terms of growth do not stop at the tax advantages discussed above.
First of all, it is important to be aware that, in the eyes of the interested public, a company is a legal form that is more credible. Thus, when the time comes to obtain financing from an investor, for example, it is highly likely that he will look for you to be incorporated before trusting you with his capital. The same will be true for a bank from which you will seek a loan to develop your business or from an organization that offers grants to small businesses: incorporation is often a prerequisite. On the contrary, the unity of the patrimony of the sole proprietorship limits very strongly the financing capacities of your business.
It is quite possible to start your business as a sole proprietorship and to change your legal form later on if necessary. The key is to know when, as the business grows, it is appropriate to incorporate a company to manage your business in order to maximize its development. Note that in the event of a change in corporate form, you will have to anticipate certain additional costs related to the turnover of assets from a sole proprietorship to a company.
If you are wondering about the best legal form to adopt for your business needs, our team will be pleased to inform you and guide you towards the choices that correspond to you.
Conclusion
You will have understood that there is no best legal form to operate a business. Everything depends on the stage of growth of the business and the needs and ambitions of each entrepreneur. Each legal form has certain advantages and disadvantages, so it is always preferable to consult a professional if you are not sure which form is best suited to your situation.
If you are interested in incorporation or if you are simply wondering about the legal form that would suit you best, contact us now to ask our team all your questions free of charge.
