This Primer for Start Up Businesses provides an overview of primary legal issues that founders, private equity funds and venture capital funds should consider.
SECTION 1: BUSINESS STRUCTURES
One of the most important legal decisions when starting a new business is determining the type of business organization that is most beneficial for your particular business. The type of organization will have important legal implications, including how the business is taxed, the ways in which it can raise capital, and the personal liability of the individuals controlling the business. This Primer sets out the most common business structures, which include sole proprietorships, partnerships, and corporations.
SOLE PROPRIETORSHIP
- A sole proprietorship is the most basic form of business organization and can be used in a wide variety of circumstances. A sole proprietorship exists whenever an individual carries on business for their own account without the involvement of other individuals, except as employees. The owner is personally responsible for all of the obligations of the business and receives all of the profits derived from its operation. Finally, as the sole proprietor is the one who owns the assets of the organization, the sole proprietor has to transfer ownership of the relevant assets, not the sole proprietorship. This results in the dissolution of the sole proprietorship.
- Sole proprietorships are relatively inexpensive to set up and require few legal formalities. Some other advantages of organizing as a sole proprietorship are the control of the sole owner over decision-making, the ability to deduct business losses against other personal income, and the low regulatory burden.
- A major disadvantage of sole proprietorships is that there is no limited liability for the This means that all business and personal assets may be seized in satisfaction of the sole proprietor's business obligations and liabilities. The owner may limit their personal liability exposure by contract or through insurance. Another disadvantage is raising capital. It is not possible to divide up ownership of the sole proprietorship which means that the sole proprietor would only be able to borrow money to raise capital.
PARTNERSHIP
- A partnership is created when two or more individuals or corporations carry on business together with a view to profit. The members of the partnership are called partners. The partners carry on the business themselves directly since the partnership is not a legal entity separate from the partners. The rights and obligations of the partners are usually set out in a formal partnership agreement; however, absent such agreement, the partnership is governed by the rules set out in Ontario legislation, including the Partnerships Act and the Limited Partnerships Act.
- Partners may be admitted to the partnership if all other partners consent. A partnership agreement may further set out requirements to become a partner, including financial contributions to the partnership. It is also common for new partners to agree to take on the existing liabilities of the partnership. A partnership agreement may also set out the rights and obligations of departing partners, including instances in which a partner must leave the partnership. Ownership in a partnership may be transferred; however, certain restrictions may be set out in the partnership agreement.
- A partnership is relatively inexpensive to set up and there are few legal formalities required to create it. In addition, income and losses are taxed in the partners' hands, meaning that each partner can apply its share of losses from operating the business against other income sources.
- Since a partnership has no separate legal identity from its partners, depending on the partnership structure being used, a partner may carry unlimited personal liability for the business' obligations. Instead, individuals may set up a limited partnership where there is one or more "general partners" whose liability is unlimited and one or more "limited partners" whose liability is limited to the amount they have contributed or agreed to contribute to the partnership business.
CORPORATION
- A corporation is the most common form of business organization. It is a legal entity separate in law from its owners and can own property, carry on business, enter into contractual relationships, possess rights, and incur liabilities. Although the shareholders own the corporation through their ownership of shares, they do not own the property belonging to the corporation, and the rights and liabilities of the corporation are not the rights and liabilities of the shareholders.
- A corporation may be incorporated under federal or provincial legislation. In Ontario, a company is incorporated under the Business Corporations Act and in Canada, a company is incorporated under the Canada Business Corporations Act. A federally incorporated company has the right to carry on business and use its name in all By contrast, a company incorporated in Ontario can only carry on business in Ontario unless it obtains a license under the extra-provincial licensing statute of another province. In order to incorporate, a business must file articles of incorporation and other supporting documents and fees to the appropriate government authority. Once the articles have been filed, a certificate of incorporation will be issued.
- Shareholders' liability is limited to the value of the assets they have transferred to the corporation in exchange for shares. In addition, a corporation continues notwithstanding the death or withdrawal of a shareholder by the sale of their shares. Lastly, there is greater flexibility to raise capital.
- Some disadvantages include the higher costs of organizing the corporation and the increased burden of regulatory oversight.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be ought about your specific circumstances.