Things to Consider When Organizing a Business

The topics in the Dial-A-Law series provide general information on legal issues within the Province of Alberta. The purpose of this topic is to inform you of your legal rights and responsibilities. This is not legal advice. If you require legal advice, you should contact a lawyer.

 

This topic will discuss some things you should consider when organizing a business. You should consult a lawyer to assist you in determining the best way to organize your business.

 

A business may be organized in many different forms. Three common forms are discussed below.

 

Sole Proprietorship

A sole proprietorship is the simplest kind of business structure. It is a business owned and operated by one person. If you are a sole proprietor, or if you are considering becoming a sole proprietor, some things you should be aware of include:

 

  • Sole proprietors are solely responsible for making all business decisions.
  • Sole proprietors receive all the profits and claim all the losses of a business.
  • Sole proprietors are personally liable for the debts and liabilities of a business. This means that if your business does not succeed financially, all of your property and assets, including your personal property and assets, can be seized for payment against the debts of your business.
  • Sole proprietors pay personal income tax on their business’s net income.
  • Sole proprietors must comply with local licensing requirements.
  • An Alberta sole proprietorship is sometimes called an Alberta trade name. You may choose to register a trade name or operate under your own name (or both). If you set up a business under only your own name, you do not need to register the business in Alberta. However, if you choose to operate a sole proprietorship under any other name, the name must be approved by the provincial Corporate Registry and registered.
  • Generally, it is a good idea to have a separate bank account for your business. If your business has a name other than your own, you will have to have a separate bank account in order to process cheques payable to the business.

 

Partnerships

A partnership is a business where two or more persons join together to carry on a trade or a business (it can also involve two or more corporates, trusts, or partnerships). If you are considering forming a partnership, some things you should be aware of include:

 

  • There is no limit on how many partners a business may have.
  • A partnership may be informal, a simple verbal agreement can be enough to form a partnership. However, most partnerships are formed and governed by a written agreement. The written agreement generally sets out rules for partners entering or leaving the partnership, the division of partnership income and other matters.
  • A partnership is a legal entity. It can do all of the things an individual can do, such as borrow money, pay wages, sue another party, be sued, and own property.
  • Partnerships are bound by the actions of any member of the partnership, as long as the actions are within the usual scope of the partnership’s operations.
  • A partnership by itself does not pay income tax and it does not file an annual income tax return. Instead, each partner includes a share of the partnership income on their tax return. There are specific forms that partners need to file to comply with partnership taxation requirements.

 

There are different types of partnerships. Some important differences between two types of partnerships, limited and general, are reviewed below:

 

  • In a general partnership, each partner is jointly and severally liable for the debts of the partnership. This means that each partner is responsible for all debts and obligations that the other partner incurs in the name of the partnership and each partner is responsible for the conduct of other partners when acting in the ordinary course of business. A Declaration of Partnership should be completed when registering a general partnership.
  • In a limited partnership, there are one or more persons who act as “general” or “managing” partners. The other partners are considered “limited” or “silent” partners. As long as a limited partner does not take part in the management of the business, that limited partner is liable only to the extent of their investment. If a limited partner takes on a management role within the business, then that partner’s liability changes to that of a general partner.

 

Incorporation

 A corporation is an independent legal entity that is owned by its shareholders and is managed by its directors and officers (who may or may not also be shareholders). Because a corporation is a separate legal entity, it can do all of the things an individual can do. A corporation can borrow money, pay wages, sue another party, be sued, pay taxes and own property.

 

Some of the advantages of incorporating a business include:

 

  • Limited liability. This is main advantage to incorporating a business. The shareholders and directors of a corporation are generally not personally responsible for the debts and obligations of the corporation. In contrast, in a sole proprietorship, the business owner is fully liable for the business.
  • It is generally easier to obtain outside investment financing if your business is incorporated, as someone who invests in a corporation (a shareholder) does not run the risk of being held responsible for the corporation’s debts. While shareholders run the risk of their shares become worthless, when the corporation prospers, the investor’s shares gain value. This structure incentivizes outside investment.
  • A corporation can outlive the people who created it, it has an unlimited lifespan. It will continue to exist even if shareholders leave the business or die. In this aspect, selling a corporation is more straightforward than selling other types of business organizations.
  • There are various tax advantages to incorporating a business. The advantages vary depending on the circumstances. Consult an accountant or a tax lawyer for further information, as tax law is complicated and changes frequently.

 

Some of the disadvantages to incorporating a business include:

 

  • Corporations are generally the most expensive form of business to set up and operate, as more formalities and paperwork are required. For instance, in order to establish a corporation, articles of incorporation need to be filed with the Alberta Corporate Registry, incorporation fees must be paid, and by-laws need to be drafted and adopted. Documents such as director and shareholder resolutions also need to be prepared.
  • The name requirements for corporations are stricter than they are for a proprietorship or a partnership. Unlike other business, identically named corporations are not allowed. In order to ensure that no other corporation has an identical (or very similar name), you will need to get an Alberta NUANS report to review. However, it is possible to create a “numbered corporation”, in which you do not need a NUANS report.
  • It is likely that you will incur legal fees, as you should consult a lawyer if you are planning to incorporate a business.
  • There is more ongoing paperwork involved with a corporation. Documents such as annual reports and tax returns must be filed. Such requirements must be met (as well as other requirements) in order for a corporation to remain in good standing with the Corporate Registry.
  • For small incorporated businesses, business owners are often asked to personally guarantee the corporation’s debts (generally bank loans). Equipment and inventory suppliers also frequently demand personal guarantees. A personal guarantee makes the guarantor personally liable for the corporation’s debts. This essentially voids the limited liability advantage of incorporating a business.

 

Dial-A-Law is a Calgary Legal Guidance public service project funded in part by the Alberta Law Foundation.