Business – maybe you work in one! Maybe you just quit working in one to start your own.
A study by Bentley University says that 67% of millennials want to start their own business. This is compared to only 13% who want to climb the corporate ladder.
We heard you loud and clear. If you want to start your own business – you might want to learn which business model works for you.
The three main business models are the sole proprietorship, partnership and corporation.
The Sole Proprietorship
This means you, yourself and I.
The sole proprietorship is the simplest business model.
It is used when you want to start selling things (goods or services) to the public with as little hassle and expense as possible.
The goods news – there is virtually no cost to setting up a sole proprietorship. In Ontario, the only cost is to register a business name which has to be renewed every five years. Once you’re registered, your business is set up. Sell away!
Since this is a single person operation, the sole proprietor has direct control over the decision-making and management of the business. As you’re running the show solo, you’re entitled to all of the business profits. Great news, right?
It is – but keep in mind that you are also personally responsible for all of the business losses. And liability is unlimited. This means that if the business fails and monies are owed, both the business assets and your personal assets can be taken. If your business borrows money – the bank can come after your business…and your home.
Takeaways for being a sole proprietor:
- Quick, low cost setup
- Full control over the business
- Entitled to all profits (and personally responsible for all losses)
- Unlimited liability
This is you, someone else, and maybe some more people.
A partnership is two or more people who want to do business together and profit! Everyone operates the business and shares in the management and profits.
A partnership can sign contracts and borrow money in its own right. But don’t be confused – a partnership is not a separate legal entity (like a company, more on that later).
The two main forms of a partnership are general and limited partnerships.
There is also a Limited Liability Partnership – LLP – which can be used for lawyers, paralegals and chartered accountants – but we won’t go into this.
In a general partnership, each partner is on the hook (liable) individually and collectively (jointly and severally) for all debts and obligations of the partnership. Everyone is also on the hook for any wrongful acts or omissions of a partner acting in the normal course of business (such as mistakes or intentional acts).
In a partnership, no good deed will go unpunished – you may have to pay out of your own pocket for a bad thing one of your partner does.
The assets and liabilities – things you own and things you owe – of the partnership are the assets and liabilities of the partners. This means that if your partnership owes a million dollars, you and your partners owe this money.
If your partner takes out a loan of a million dollars on behalf of the partnership, you may also be on the hook for this money.
Moral of the story – trust your partners!
There is no requirement to have a partnership agreement. That being said, it is highly recommended to have one. The partnership agreement could be very simple. You can sort out and set out the expectations of the partners.
Think about who and how:
- Who will manage the business?
- how much money (or other assets – like property) is each partner contributing?
- How will you slice the pie (allocate profits and losses)?
Without a partnership agreement, the default rules in the Partnerships Act (Ontario) would govern and these rules may not be what you had intended.
In a limited partnership, the liability of the limited partner is limited to the amount of money they contributed to the partnership. This means if you put in 1$ into the partnership, you’re only on the hook for 1$. If your partner steals a million dollars – you only have to worry about your 1$.
The partnership must involve at least one general partner and at least one limited partner.
Before you get too excited – you should know that a limited partner does not have a management role in the partnership. As a limited partner, you’re really just an investor. If you suddenly wanted to take charge, you lose your limited partner status.
The general partner manages the partnership – and they still have all the liability. Cue the sad trombone wah wah wah music.
A neat way to get around the sad trombone music – a corporation can be a general partner (rather than an individual). So a general partner is leading the partnership through this company making the company liable
There are some decisions of the partnership that may require the consent of the limited partners and these are set out in the Limited Partnerships Act (Ontario).
Limited partners generally share in the profits of the partnership in relation to their contributions, but as in a general partnership this can be changed by agreement (which you should have!).
Creating a Partnership
To create a general partnership, the only formality is that you need to register your business or partnership name. To create a limited partnership, the general partner of a limited partnership must file a Declaration. This Declaration must be renewed every five years.
Takeaways for our partnerships:
- Two main types: general and limited
- In a general partnership: Joint and several liability for all partners
- In a limited partnership: General partners have unlimited liability but limited partners are only liable for what they contribute or agree to contribute
- You should have a partnership agreement
This is an iron wall (or what we learn in law school to be a curtain) between you and your business. Iron wall sounds cooler.
In your life, I’m sure you have bought something from a company. Ever wondered how companies are structured?
A corporation is owned by its shareholders and managed by its directors. The directors may delegate responsibilities to its officers.
In Ontario, for-profit business corporations are governed by the Business Corporations Act (Ontario).
A corporation is a separate legal entity. It is kind of like its own person. Yes – person.
Shareholders are not personally liable for any acts, debts or obligations of the corporation. The most you’ll lose as a shareholder is the equity you contributed to the corporation. If you put in $5,000 into bitcoin stocks, the most money you lose is how much you paid in shares, which is $5.000. See why companies are a good business model?
A corporation can enter into agreements, own property and be responsible for the business.
Corporations are ideal – no one is coming after your house and you don’t have to partner up and worry about them dragging you through the mud.
But – directors and officers do have some liability for their acts on behalf of the corporation. There is no such thing as ever getting away scot free. Lucky for the officer/director, the corporation can get insurance to help protect them.
Formation of a Corporation
To form a company you need to file Articles of Incorporation. You can file them federally or provincially, depending on where the corporation will be carrying on business. These Articles set out who, what and how:
- who the first directors of the corporation will be;
- what the rights associated with each class, and;
- how the classes of shares that the corporation will have will be allocated.
The role of shareholders as owners?
When I said scot free I meant that directors couldn’t just make really big decisions on their own. They aren’t the owners. When you bought Bitcoin, you became an owner! You may have some say in the company – for example – if you’re a voting shareholder.
There are certain fundamental changes that require shareholder approval. Yes – shareholders get together and do the whole old school thing where they put their hands up and vote on decisions. These decisions take place in the form of meetings or by resolution.
Shareholders can have even more control over the business by having a unanimous shareholders agreement. This restricts the powers of the directors.
You probably know this – but shareholders can also share in the profits of the business. If you’ve bought BCE, you probably did for the dividends (or at least that’s what I read on LinkedIn).
So limited risk and profits – it’s good to be a shareholder!
Process to incorporate
Once the Articles have been filed, the corporation exists. Wahoo!
But the work doesn’t stop there – the corporation must be organized – Directors need to elected, officers appointed and shares issued. Ongoing activity should be recorded in the company minute book.
Compared to sole proprietorships or partnerships, corporations are more expensive to set up and operate. In Ontario, filing Articles of Incorporation costs $330, with an additional expense if the corporation will have a name rather than a number name.
Takeaways for our corporations:
- Separate legal entity
- Limited liability
- More expensive to set up and operate
There are many ways to dive into a pool
Maybe you want to just dive in head first and take the risk – like a sole proprietor.
Maybe you want to dive in with a friend together – like a partnership.
Or maybe you want to stand on the sidelines, and direct your imaginary friend into diving – okay, this is a terrible analogy – hopefully you get the point.
All to say, you should know what you are comfortable with. How much risk are you willing to take for your new business venture?
If it’s a lemonade stand, being a sole proprietor makes sense. If it’s a venture capital company investing millions of dollars – you should consider a company.
And if you decided to keep your day job and never be an entrepreneur that is fine – the pool nearby has a diving board and it is just waiting for you to figure out how you’ll jump in.