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Choosing the right business structure

Choosing the right business structure

When you are starting out as a new entrepreneur, there are various choices you will have to make to ensure proper growth of your business. One of the most important is your business structure, also referred to as legal structure. Choosing the right business structure is probably the earliest decisions you have to make while starting a new business as it determines the course of your company. Although it is possible to change the legal structure of your business as it expands, making this decision now will help you anticipate your future needs more easily and in a cost-effective manner.

There are many legal structures that one can choose for their business including Community Interest Companies and Public Limited Company (PLC). All these structures are highly specialized and are not the common choice among most new entrepreneurs. The most common and basic business structures are: sole proprietorships, partnerships and corporations. In this article, we will be discussing the pros and cons of these three basic business structures.

Sole Proprietorships

Sole Proprietorship is probably the simplest and the most common type of business structure among many new entrepreneurs. As the name suggests, this legal structure involves just one individual who owns and operates the entire company. If you choose this form of structure for your business, then you, as the owner, will alone be responsible for every aspect of your business from profits and assets, to debts and liabilities.

Pros:

  • In sole proprietorship, as the owner handles all aspects of the business, this might be the best course for those who like taking the lead.
  • It is easy to register your business if you choose this form of legal structure.
  • The proprietor owns all the business assets personally.
  • Startup and business maintenance is relatively easier with lower overheads.
  • In certain situations there may also be some tax advantage to the owner..

Cons:

  • Choosing sole proprietorship business structure means, you will solely be responsible for your personal and your company’s liabilities.
  • The owner usually, has to depend on his personal financial sources as banks and other loan providing agencies do not favor sole proprietorship businesses.
  • In case the sole proprietor dies, the business also ends.
  • While transferring the ownership of the business, the proprietor needs to sell all his business assets.
  • All the profits of your business will be tied to your income tax.

Partnerships

It is a business structure in which two or more persons run a company by sharing their resources, profits and liabilities. Just like in sole proprietorship, partners in this business structure can hire managers & other employees, to help them run the business, but are accountable for all profits and losses, as described in the Partnership agreement.
There are two types of partnerships:

  • General partnership and
  • Limited partnership.

General partnership is the common one out of these two types. In this business structure, the general partners own and operate the business themselves while taking accountability of the profits as well as the liabilities. In a limited partnership, some partner can serve as investors only, hence having limited responsibility to the company. The limited partners do not manage the company and are not subjected to the same liabilities as the general partners.

Pros:

  • There are limited regulations to follow.
  • The partners own all the business assets by themselves.
  • The startup and operation capital is much less than in corporation.
  • For big enterprises, there will be several sources of initial investment capitals.
  • The profits are shared by all the partners. The taxable income in terms of income tax will thus be reduced.

Cons:

  • If you share the profits that means you have to share any debts or liabilities too (except in case of limited partners)
  • There could be tension between two partners in terms of authority and decision-making. Falling out between partners will lead to downfall of the business.
  • This business structure is not recommended to those who are starting a small-scale business where the investment is quite low.
  • All the profits are taxed to the individual partners’ personal income tax which is usually higher than corporate tax rate.

Corporations

In corporations, the legal entity of the company is the company itself and not the owner. This means that all the revenue, losses and taxes of the company are separately accounted from their owners. Corporations are owned by a group of people who are referred as shareholders. You can also choose to incorporate federally or provincially depending on your business type, its strengths and weaknesses.

Pros:

  • As the company is entitled as a separate individual in this form of legal structure, the owner’s liability is reduced to what they invest in the company.
  • In terms of taxes too, the owners or shareholders will only pay taxes on corporate profits (in terms of salaries, bonuses and dividends)
  • Unlike sole proprietorship or partnership, it is possible to transfer ownership without any complications.
  • The company will thrive even if certain shareholders leave the company.

Cons:

  • Using corporate structure is more expensive and complex than other business structures mentioned above.
  • To start a business as a corporation you might be required to have at least permanent residency.
  • Two or more income tax returns are required with extra bookkeeping and record keeping.
SubhashSharma

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Mr. Sharma is a management accountant with over 33 years of experience in small business. He has been engaged in independent accounting practice since 2003. With MBA degree in IT Management and CPA, CMA designation he believes in creating value for the clients. Mr. Sharma has been actively involved in imports, exports, retail, construction and IT consulting. He has written articles in the “Canadian Immigrant” magazine on taxation and accounting for small business. He has served as director on the boards of York Regional Community Foundation, Community Living of York South and Surrey Foundation. He is a member of CAPS (Canadian Association of Professional Speakers), Rotary Club of Richmond Hill, Markham Board of Trade and Richmond Hill Chamber of Commerce.

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