Legal Forms of Business Ownership in Canada

Innovation, Science and Economic Development Canada (ISED) defines a business based upon the number of paid employees. For this reason, self-employed and “indeterminate” businesses are generally not included in the present publication as they do not have paid employees.

Accordingly, this publication defines an SME (small-to-medium enterprise) as a business establishment with 1–499 paid employees, more specifically:

• A small business has 1 to 99 paid employees.
• A medium-sized business has 100 to 499 paid employees.
• A large business has 500 or more paid employees.

ISED also categorizes businesses with 1-4 employees as micro-enterprises.

Factors to Consider

If you’re starting a new business, you have to decide which legal form of ownership is best for you and your business. Do you want to own the business yourself and operate as a sole proprietorship? Or, do you want to share ownership, operating as a partnership or a corporation? Before we discuss the pros and cons of these three types of ownership, let’s address some of the questions that you’d probably ask yourself in choosing the appropriate legal form for your business.

1. In setting up your business, do you want to minimize the costs of getting started? Do you hope to avoid complex government regulations and reporting requirements?
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2. How much control would you like? How much responsibility for running the business are you willing to share? What about sharing the profits?
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3. Do you want to avoid special taxes?
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4. Do you have all the skills needed to run the business?
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5. Are you likely to get along with your co-owners over an extended period?
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6. Is it important to you that the business survives you?
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7. What are your financing needs and how do you plan to finance your company?
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8. How much personal exposure to liability are you willing to accept? Do you feel uneasy about accepting personal liability for the actions of fellow owners?

No single form of ownership will give you everything you desire. You’ll have to make some trade-offs. Because each option has both advantages and disadvantages, your job is to decide which one offers the features that are most important to you. In the following sections, we’ll compare three ownership options (sole proprietorship, partnership, and corporation).

Finding the Right Business Structure ^[1]

Going it Alone: Sole Proprietorships

Jeremy Shepherd was working full-time for an airline when, at the age of 22, he wandered into an exotic pearl market in China, searching for a gift for his girlfriend. The strand of pearls he handpicked by instinct was later valued by a jeweler back in the States at 20 times what he paid for it. Jeremy cashed his next paycheck and hurried back to Asia, buying every pearl he could afford. Founded in 1996, his company Pearl Paradise was brought online in 2000. Shepherd chose the sole proprietorship form of business organization—a business that is established, owned, operated, and often financed by one person—because it was the easiest to set up. He did not want partners, and low liability exposure made incorporating unnecessary.

Fluent in Mandarin Chinese, Japanese, and Spanish and immersed in Asian culture, Shepherd believed the internet was the way to market his pearls (http://www.pearlparadise.com). Offering a wide range of pearl jewelry through 14 websites worldwide, his company sells as many as 1,000 items per day. The recent addition of an exclusive Los Angeles showroom allows celebrity customers to shop by appointment. With $20 million in sales annually, PearlParadise.com is the industry leader in terms of sales and volume. ^{[2] [3] [4]}

Advantages of Sole Proprietorships

In a sole proprietorship, you make all important decisions and are generally responsible for all day-to-day activities. In exchange for assuming all this responsibility, you get all the income the business earns. Profits earned are taxed as personal income, so you don’t have to pay any special federal and provincial income taxes.

Disadvantages of Sole Proprietorships

The sole proprietorship may be a suitable choice for a one-person start-up operation with no employees and little risk of liability exposure. For many sole proprietors, however, this is a temporary choice, and as the business grows, the owner may be unable to operate with limited financial and managerial resources. At this point, the owner may decide to take in one or more partners to ensure that the business continues to flourish.

Partnerships: Sharing the Load

Can partnerships, an association of two or more individuals who agree to operate a business together for profit, be hazardous to a business’s health? Let’s assume partners Ron and Liz own a stylish and successful beauty salon. After a few years of operating the business, they find they have contrasting visions for their company. Liz is happy with the status quo, while Ron wants to expand the business by bringing in investors and opening salons in other locations.

How do they resolve this impasse? By asking themselves some tough questions. Whose view of the future is more realistic? Does the business actually have the expansion potential Ron believes it does? Where will he find investors to make his dream of multiple locations a reality? Is he willing to dissolve the partnership and start over again on his own? And who would have the right to their clients?

Ron realizes that expanding the business in line with his vision would require a large financial risk and that his partnership with Liz offers many advantages he would miss in a sole proprietorship form of business organization. After much consideration, he decides to leave things as they are.

For those individuals who do not like to “go it alone,” a partnership is relatively simple to set up. Offering a shared form of business ownership, it is a popular choice for professional service firms such as lawyers, accountants, architects, stockbrokers, and real estate companies.

The parties agree, either orally or in writing, to share in the profits and losses of a joint enterprise. A written partnership agreement, spelling out the terms and conditions of the partnership, is recommended to prevent later conflicts between the partners. Such agreements typically include the name of the partnership, its purpose, and the contributions of each partner (financial, asset, skill/talent). It also outlines the responsibilities and duties of each partner and their compensation structure (salary, profit sharing, etc.). It should contain provisions for the addition of new partners, the sale of partnership interests, and procedures for resolving conflicts, dissolving the business, and distributing the assets.

There are two basic types of partnerships: general and limited. In a general partnership, all partners share in the management and profits. They co-own the assets, and each can act on behalf of the firm. Each partner also has unlimited liability for all the business obligations of the firm. A limited partnership has two types of partners: one or more general partners, who have unlimited liability, and one or more limited partners, whose liability is limited to the amount of their investment. In return for limited liability, limited partners agree not to take part in the day-to-day management of the firm. They help to finance the business, but the general partners maintain operational control.

There are also limited liability partnerships (LLP), which are similar to a general partnership except that partners are not held responsible for the business debt and liabilities.

Advantages of Partnerships

Picking the Perfect Partner

Picking a partner is both an art and a science. Someone may have all the right credentials on paper, but does that person share your vision and the ideas you have for your company? Are they a straight shooter? Honesty, integrity, and ethics are important, because you may be liable for what your partner does. Be prepared to talk about everything, and trust your intuition and your gut feelings—they’re probably right. Ask yourself and your potential partner the following questions—then see how well your answers match up:

1. Why do you want a partner?
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2. What characteristics, talents, and skills does each person bring to the partnership?
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3. How will you divide responsibilities—from long-range planning to daily operations? Who will handle such tasks as marketing, sales, accounting, and customer service?
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4. What is your long-term vision for the business—its size, life span, financial commitment, etc.?
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5. What are your personal reasons for forming this company? Are you looking to create a small company or build a large one? Are you seeking a steady paycheck or financial independence?
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6. Will all parties put in the same amount of time, or is there an alternative arrangement that is acceptable to everyone?
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7. Do you have similar work ethics and values?
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8. What requirements will be in the partnership agreement?

Disadvantages of Partnerships

Business partnerships are often compared to marriages. As with a marriage, choosing the right partner is critical. So if you are considering forming a partnership, allow plenty of time to evaluate your and your potential partner’s goals, personality, expertise, and working style before joining forces.

Corporations: Limiting Your Liability

A corporation (sometimes called a regular or C-corporation) differs from a sole proprietorship and a partnership because it’s a legal entity that is entirely separate from the parties who own it. It can enter into binding contracts, buy and sell property, sue and be sued, be held responsible for its actions, and be taxed. Once businesses reach any substantial size, it is advantageous to organize as a corporation so that its owners can limit their liability. Corporations, then, tend to be far larger, on average, than businesses using other forms of ownership. Most large well-known businesses are corporations, but so are many of the smaller firms with which likely you do business.

According to the most recent data from Statistics Canada, as of December 2019, approximately 10.8% of all active businesses in Canada were corporations. This means that the vast majority of businesses in Canada are either sole proprietorships or partnerships. However, it’s worth noting that the percentage of incorporated businesses may vary depending on the industry and region. For example, certain industries such as finance and insurance are more likely to be incorporated, while others such as construction and retail are more likely to be sole proprietorships or partnerships.

The top corporations in Canada can vary from year to year, but here are some of the largest and most well-known companies based on revenue and market capitalization:

1. Royal Bank of Canada (financial services)
2. TD Bank Group (financial services)
3. Enbridge Inc. (energy)
4. Suncor Energy Inc. (energy)
5. Brookfield Asset Management Inc. (asset management)
6. Canadian National Railway Company (Transportation)
7. Bank of Nova Scotia (financial services)
8. Canadian Natural Resources Limited (energy)
9. BCE Inc. (telecommunications)
10. Toronto-Dominion Bank (financial services)

The Incorporation Process

Incorporation is the process of creating a separate legal entity for a business. This means that the business is considered a separate “person” in the eyes of the law, with its own rights, liabilities, and obligations. In Canada, incorporating a business involves the following steps:

1. Choose a name: The first step in incorporating a business is to choose a name. The name must be unique and not already registered with the Canadian government.
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2. Decide on the type of corporation: There are several types of corporations in Canada, including federal corporations, provincial corporations, and non-profit corporations. The type of corporation you choose will depend on your business needs and goals.
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3. Choose a jurisdiction: If you choose to incorporate provincially, you will need to choose the province or territory where you want to incorporate. If you choose to incorporate federally, you will be able to operate across all provinces and territories in Canada.
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4. Prepare and file the articles of incorporation: The articles of incorporation are the legal documents that formally create the corporation. These documents will include information such as the corporation’s name, its business purpose, its share structure, and the names of its directors.
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5. Obtain a business number: After the articles of incorporation are filed and approved, you will need to obtain a business number from the Canada Revenue Agency (CRA). This number will be used to identify your business for tax purposes.
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6. Register for taxes: Depending on the type of business you are running, you may need to register for certain taxes, such as the Goods and Services Tax/Harmonized Sales Tax (GST/HST) or the payroll taxes.
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7. Obtain any necessary licenses and permits: Depending on the nature of your business, you may need to obtain additional licenses or permits from various levels of government.

Once these steps are complete, your business will be officially incorporated and will have a separate legal status. You will need to comply with various regulations and requirements to maintain your corporation’s status, such as holding annual meetings and filing annual reports.

Ownership and Stock

Corporations are owned by shareholders who invest money in the business by buying shares of stock. The portion of the corporation they own depends on the percentage of stock they hold. For example, if a corporation has issued 100 shares of stock, and you own 30 shares, you own 30 percent of the company. The shareholders elect a board of directors, a group of people (primarily from outside the corporation) who are legally responsible for governing the corporation. The board oversees the major policies and decisions made by the corporation, sets goals, and holds management accountable for achieving them, and hires and evaluates the top executive, generally called the CEO (chief executive officer). The board also approves the distribution of income to shareholders in the form of cash payments called dividends.

Advantages of Corporations

Disadvantages of Corporations