With a calculator in our hand, our commercial dream starts. Soon, one realizes that beyond the yearning for profits one also needs to seriously consider the risks and potential losses associated with our business.
To avoid one’s dream becoming a nightmare, before one embarks on a business venture one must choose its appropriate organization from a legal standpoint.
There are three basic business organizations: sole proprietorships, partnerships and corporations. Each of them must meet legal requirements and has its own advantages and disadvantages.
Sole proprietorships
A sole proprietorship arises once a person begins to conduct business (for example, baking and selling muffins for money).
There is no separation between the business and the proprietor (owner). For this reason, the proprietor is entitled to all income but at the same time is liable for all obligations, with the proprietor’s assets being available for any business debts.
The sole proprietor cannot be an employee of the business, and the business income or loss has an impact on the proprietor’s personal income.
In Ontario, no individual may carry on business or identify his or her business to the public under a name other than his or her own name unless the name is registered by that individual under the Ontario Business Names Act (“BNA”).2 Also, depending on the type of business, a business licence may be required.
The main advantage of a sole proprietorship is its simple start (i.e. it arises once a person begins to conduct business). However, it has serious disadvantages. First, the proprietor has unlimited personal liability. Second, the money the owner can raise for the business is only by personal borrowing. It is important to note that both problems grow as the business grows.
As a result, a sole proprietorship is generally suitable for small businesses that do not involve significant risks.
Partnerships
There are three main types of partnerships: general partnerships, limited partnerships, and limited liability partnerships. A detailed description of each of these partnerships exceeds the scope of this article, which focuses only on general partnerships.
A general partnership exists when two or more people carry on business together with a view to a profit. A partnership creation is automatic when the business relationship begins, and no formalities are required.
In Ontario, no persons associated in partnership may carry on business or identify themselves to the public unless the firm name of the partnership is registered by all of the partners.3 However, persons associated in partnership may carry on business and identify themselves to the public under a name that is composed of the names of the partners.4
To determine whether a partnership exists, the courts will look at the true intentions of the parties and the nature of their business relationship. The courts will consider several factors to find whether a partnership exists. The following factors indicate the existence of a partnership:
- sharing profits (not just revenues) or losses
- jointly owning property or jointly contributing capital to the business venture
- involvement in business —especially management
- joint authority for contracts and bank accounts
- equal access to business information
- holding each other out as partners or acquiescing to such holding
- engaging in ongoing activity rather than one project
The presence of the abovementioned factors is positive if the persons associated in partnership wish to indeed carry on business together and the establishment of a partnership is their true intention. However, one of the negative aspects of the ease of establishing a partnership is that one may inadvertently be in a partnership without truly wishing it. Since the abovementioned factors may inadvertently exist, one must seriously consider the risks of being involved in an unintended partnership. This may happen in situations where, for example, one is assisting a friend or family member with establishing their business without willing to carry on business together with them. The unlimited personal liability of the partners is the main risk of a partnership. Therefore, it is crucial that one avoids the risks of inadvertent partnerships.
The main characteristics of a partnership are:
- there is no separation between a partner and the partnership
- partners have unlimited personal liability
- income to the partnership is the personal income to partners
- The Ontario Partnerships Act5 provides default rules, which can be supplemented or modified by a partnership agreement
- each partner can commit the partnership to obligations
As it is easy to establish a partnership it is also very easy to end a partnership. Unless the partners agree otherwise, the default termination rules are as follows: any partner may terminate partnership on notice and termination occurs upon the death or insolvency of a partner.
Corporations
A corporation is an entity that is established pursuant to a statute (such as the Ontario Business Corporations Act or the Canada Business Corporations Act) and once is incorporated it can enter into agreements, own assets, incur debt, sue and be sued. A corporation is a statutory creature that is created by incorporation under the pertinent business corporations act. The Ontario Business Corporations Act defines a corporation as a body corporate with share capital.6
The main characteristics of a corporation are:
- separate legal personality
- limited liability of its shareholders
- transferable shares
- delegated management with a board structure
- investor ownership by way of shareholding
- right to control
- right to receive the corporation’s net earnings
The main advantage of choosing a corporation as one’s business organization is its separate legal personality (i.e. the shareholders/investors are legally separate from the corporation) and the limited liability of its shareholders (i.e. the investors/shareholders limit their business exposure to their capital contributions to the corporation).
It is important to note that there are some special kinds of corporations to which specific statutes apply (for example, banks, insurance companies, charities, and non-for-profit organizations).
Not all businesses are created equal. For this reason, there is no “cookie-cutter” approach to choosing the legal form for your business. The chosen business organization must be tailored to the specific needs, industry, risks, and characteristics of your business. We can help you navigate this important step in setting up your business and assist you with assessing your business’s risks.
Disclaimer: This article should not be taken as legal advice. It contains some general legal information on the topic covered in this article.
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2 Business Names Act, R.S.O. 1990, c. B.17, s. 2(2).
3 BNA, s. 2(3). This prohibition does not apply to forbid persons associated in a limited partnership from carrying on business under the firm name in accordance with the Limited Partnerships Act (BNA, s. 2(3.3)).
4 BNA, s. 2(4).
5 Partnerships Act, R.S.O. 1990, c. P.5.
6 Business Corporations Act, R.S.O. 1990, c. B.16, s. 1(1).
