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Starting a business requires you to think about multiple considerations among which the business structure plays a fundamental role. Any business has to have a sound structure under which it operates and grows. In Ontario, the law allows an entrepreneur to organize his or her activities under various structures that have specific legal, tax, and operating characteristics.
In this article, we will outline the most common business structures in Ontario, and what you should keep in mind for each one of them. Particularly, we will look at the:
- Sole proprietorship
- General partnership,
- Limited partnership,
- Limited liability partnership, and the
The corporation in Ontario
As an entrepreneur and business owner, one of the most important questions that arises is your liability: when will you be held personally liable for the affairs of your business? In Ontario, the business structure that allows you to limit your liability like no other is the corporation.
A corporation will be different from the business structures mentioned below because it has its own legal entity separate from the individuals forming the corporation or holding an interest in it. Therefore, from a legal and tax standpoint, the corporation has a distinct entity.
In Ontario, you can incorporate your business under the provincial or federal Act. To help you choose your law of incorporation, we invite you to read our article on how to incorporate in Ontario.
But why should you incorporate your business? Here are some of the reasons:
- Legal security: a corporation, due to its legal entity, can own property and enter into contracts without exposing its members to any liability. Unless rare circumstances, the personal assets of the corporate members are protected from the corporation’s creditors in the event that the corporation is unable to repay a debt in time. Additionally, the legal existence of a corporation continues as long as the law or the corporation’s members permit it. Therefore, a corporation may exist indefinitely.
- Financing activities: a corporation has more options to fund its activities.The first source of funding for a corporation is shares. A corporation can issue and sell shares to private or public entities, and individuals.
A share represents a percentage of interest in the activities of the corporation that grants, depending on its nature, a type of decision-making control and/or a right in the distribution of the corporation’s net income (also referred to as “dividends”).
In return of the share(s) sold, the corporation receives a monetary sum from the buyer and holder of the share: the shareholder.
The second source of funding for a corporation is loans. A corporation may receive loans to finance its activities. Unlike the money received from the sale of shares, loans represent a debt that must be repaid. That being said, a corporation may use all its assets to guarantee the loan which allows it to obtain better interest rates. In fact, loan financing allows a corporation to make its assets grow by increasing investments and, eventually, profits. Note that lenders may require that certain members of the corporation provide a personal and joint guarantee on the loan.
- Tax advantages: when the net income remains positive and unused, an incorporated business benefits from improved tax rates, deductions and exemptions, and credits on the income. For additional information on this subject, we invite you to contact a chartered accountant. If you want to be referred to our partner chartered account, please mention it in your incorporation form.
In addition, a corporation offers 2 unique protection tools to its investors: the shareholders’ and the unanimous shareholders’ agreement.
- The shareholders’ agreement is a contract between the shareholders of a corporation that governs how shareholders may act and react in particular situations. The objective of this agreement is to reduce the shareholder’s exposure to foreseeable and unforeseeable events. For example, a shareholders’ agreement usually provides the rules to follow when a shareholder wants to sell his or her shares in the corporation.
- The unanimous shareholders’ agreement is a contract of all the corporation’s owners that aims to restrict or withdraw, part or all, the powers of the Board of Directors.For example, in a corporation owned by A, B, and C, and where C holds 70% of the voting shares, although the Board of Directors may be composed of all 3 shareholders, C retains the control of the voting majority. In this case, the unanimous shareholders’ agreement of A, B, and C may require the concurring vote of A and B when voting on important matters such as the dissolution of the corporation.
To learn more about the shareholders’ and the unanimous shareholders’ agreements, we invite you to read our article on the shareholders’ agreement.
Although the corporation appears to be a complex business structure, making it simple is what we do. If you have any questions or seek more information about the incorporation process of your business, contact us!
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The sole proprietorship in Ontario
From a legal and tax standpoint, the sole proprietorship and the owner are considered the same person.
- This means that the sole proprietorship’s income is integrated to the owner’s income, and taxed using the owner’s tax rates. Although this structure may lower the owner’s personal income tax bracket, it remains limited in deducting expenses and sheltering income.
- Also, this means that the owner must raise all the necessary capital to start the business. This task may be more difficult because private lenders, financial institutions, and investors prefer investing or granting credit to incorporated rather than unincorporated businesses.
What is most important to understand is that the owner retains the full legal responsibility of the sole proprietorship’s dealings. Therefore, the assets of the owner may be seized to settle any claim against the sole proprietorship as the owner remains liable for the sole proprietorship’s liabilities. In practice, this liability can be limited by the contract between the owner and another party(ies), or covered by insurance.
Nonetheless, the sole proprietorship is the simplest and cheapest structure to use, and as soon as a person starts working on his or her own, the sole proprietorship is created. Within a sole proprietorship
- A single person owns and is responsible for the business in its entirety.
- Tracking revenues and expenses is easy because no public disclosures and accounting knowledge is required.
- All that has to be done is to open a banking business account and, if the sole proprietorship operates under a name that is different from the owner’s, to register that name under the Business Name Act.
Under this business form, the proprietor retains complete control over the decision-making, and the proprietorship’s assets and liabilities. Note that an operating licence may be required for certain types of businesses. For example, an electrician needs a licence that certifies the completion of the required training and apprenticeship.
Your business grows exponentially, or you simply want to protect your personal assets from the creditors of your sole proprietorship? You can incorporate your sole proprietorship at any time!
You want to add a partner to your business and create a partnership? The next section explains what it entails to create a partnership.
The partnership in Ontario
In Ontario, it is the association or relationship between 2 or more persons that establishes the partnership. The notion of “persons” may include other legal entities (not-for-profit organizations for example) or other enterprises that are not corporations (for example co-operatives) that enter into a partnership.
There are 3 types of partnerships:
- the general partnership,
- the limited partnership, and
- the limited liability partnership.
The following sections provide more details about these 3 types of partnerships of Ontario.
The general partnership
To create a general partnership in Ontario, the partners must carry a business with the common intention of generating a profit. This intention results from an agreement between the partners that can be oral, written or implied by action. “Implied by action” means that the behaviour of the partners and the circumstances surrounding their common activities suggest that the partners want to carry a business with the intention of making a profit out of it.
The most common way of establishing a partnership is for a sole proprietorship to add a 2nd owner; in which case the partnership is then created. Similar to a sole proprietorship, a partnership may register its name under the Business Names Act.
In a partnership, the partners share the profits and losses because they exercise all the rights and obligations jointly and severally. In other words, all the partners remain responsible for:
- The obligations of the partnership as whole, irrespective of the obligation’s source (for example, due to a contract or a legal claim) and of which partner contracted on behalf of the partnership.
- The wrongful act(s) of a partner or an employee of the partnership, irrespective of who committed the wrongful act.
As a rule of thumb, general partnerships are regulated by a partnership agreement that determines the rights and obligations of each partner. However, there is no legal requirement to have a written agreement, and in the absence of such an agreement, it is the Partnerships Act that governs the relationship.
The limited partnership
In Ontario, the limited partnership has the same objectives as the general partnership. However, it provides for 2 different types of partners: the general partner(s) and the limited partner(s).
The partners assume different responsibilities:
- The general partner manages and is responsible for the day-to-day operations of the partnership. In return, that general partner has a salary and/or receives the benefits of a limited partner.
- The limited partner is responsible for investing money or contributing with property to the partnership. In return, the limited partner receives, when proceeds are paid out, a fraction of the profits in proportion to his or her investments.
Moreover, their liabilities are different:
- The general partner retains a personal liability for all the partnership’s dealings. This liability is identical to the one of a partner in a general partnership.
- The limited partner is liable up to the amount of the capital investment into the partnership, unless the limited partner is also a general partner.
The limited partnership has to respect the rules provided by:
- The Partnerships Act,
- The Limited Partnerships Act,
- The Business Name Act (if operating under a business name), and
- Common law.
Any limited partnership has to have a partnership agreement. Fundamentally, it is the first source of law between partners. This written contract covers, modifies or adds to the matters addressed by the Partnerships and Limited Partnerships Act.
In Ontario, a limited partnership has to register with the Director of Ministry of Government and Consumer Services (hereinafter the “MGCS”) and to file a copy of the partnership agreement. This registration is valid for 5 years and can be renewed indefinitely. If you fail to file a declaration of renewal, the limited partnership is not dissolved, but additional fees are incurred for its renewal.
Note that the limited partnership is an interesting business option for foreign investors because:
- General or limited partners are not required to be the Canadian residents,
- No minimum contribution capital is required, and
- Limited partners have no audit requirements and non-Canadian residents are not subject to tax withholding on the profits received from the partnership.
For all these reasons, it is common for US trust funds, for example wealth management trusts, to invest in Canadian limited partnerships.
The limited liability partnership
In Ontario, the limited liability partnership (also known as the “LLP”) is a business structure that operates under the same canvas as the limited partnership (section 44.1). However, the LLP is permitted exclusively to persons who carry on a profession recognized by the law. Most common examples are accounting and law firms.
To be more precise, 3 conditions have to be met to establish a LLP (section 44.2):
- The Act that regulates the profession has to expressly permit its members to carry their professional activities under an LLP. In other words, a permission to establish a LLP cannot be implied based on the Act’s silence on the matter.
- The body that governs the professional order has to require the maintenance of a liability insurance.
- The LLP registers its name under the Business Names Act.
The limited liability partnership is subject to the same rules as the limited partnership, including the duty to register with the Director of the MGCS. Similarly, the LLP has 2 types of partners: general and limited partners.
General partners are joint and severally liable for the partnership, except for any act or omission to act of a partner that is deemed to be negligent. In this case, the limited partners assume the responsibility of their own negligent acts or omissions and the ones of any person under their direct control or supervision. In any other circumstance, limited partners are shielded from any liability in the course of the partnership’s business.
Note that any form of partnership can change its legal structure and incorporate at any time. How can you do that? Book an appointment with us and we will discuss it together.
In the article’s last section, we explain to you a business structure that, although rare, is becoming more and popular: it is the co-operative.
The co-operative in Ontario
The Ontario co-operative is similar to a corporation because of the advantage of having a separate legal entity and the ability to hold rights and obligations at law. Thus, a co-operative is incorporated under the provincial or the federal Act; the former is the Ontario Co-operative Corporations Act, and the latter is the Canada Cooperatives Act .
However, a co-operative remains a distinct form of business as it offers a hybrid structure. Owned by an association of persons, a co-operative seeks to meet the common economic, social, and cultural needs of its owners through the access or sale of products or services, or employment. Co-operatives share 3 common principles, where every member:
- Who uses the products or services of the co-operative owns the co-operative.
- Has one vote, irrespective of the number of shares that the member holds in the co-operative; co-operatives are democratically controlled.
- Owns the surplus of the co-operative which can be allocated to the co-operative’s reserve for future investments or distributed to the members based on their usage of the co-operative’s products or services over the last year.
Furthermore, a co-operative may benefit from a not-for-profit organization or charity status under the Income Tax Act. To learn more about what these statuses imply, we invite you to read our article about incorporating a not-for-profit organization.
Although a co-operative may serve many functions, in practice, 2 types are most common:
- Consumer or producer co-operatives
Consumer co-operatives provide products and services to their members. A known example of it is the Metro Consumers Co-Operative; a retail grocery owned by consumers to provide products to their members.
Producer co-operatives process, market, or supply goods and services to their members. For example, the Ontario Biomass Producers is a co-operative of farmers producing sustainable biomass crops provided to their members.
- Multi-stakeholder co-operatives
Multi-stakeholder co-operatives may serve the needs of a variety of groups and individuals. Often, they provide for a social support purpose and fall within the childcare or housing types. These co-operatives are generally structured as not-for-profit organizations to reinvest the surplus towards improving the services and products offered. For example, a childcare co-operative uses the capital fundraised by parent-members or paid through an annual membership to improve the day care services offered to the parent-members.
Although it is not the most common business structure in Ontario, the co-operative offers a unique way of operating a business all while staying involved within an immediate community.
To conclude, remember that:
- There are multiple legal structures possible to establish your business in Ontario. However, the corporation remains the least risky and the most flexible business option.
- You are not alone; Lex Start is here to help kick-off your business, no matter its type, without compromising your budget by offering affordable and customized legal services.
We hope that you are now more comfortable to start your own business. For more information about the corporation and the incorporation process, contact us!