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Selection of Business Entity (Page 2)
DISCLAIMER - The information provided here is of a general nature and may not apply to any specific or particular situation. It is not to be considered as a legal advice nor presumed to be indefinitely up to date.
Flexibility of control refers to the extent to which the
owners can control the conduct of the business. Partnerships provide
considerable latitude to structure the arrangement between parties. In contrast,
many of the rules governing the relationship between shareholders are mandatory.
Yet, the ability to include in the articles of incorporation provisions that may
be limited in by-laws and the availability of the unanimous shareholder
agreement can provide considerable flexibility for structuring arrangements
between shareholders. The level and degree of control is an extremely important
factor that entrepreneurs should not overlook when considering the type of
business they want to create.
The extent to which ownership interests may be transferred is an important
factor affecting the liquidity of the owners' interests. An ownership interest
in a business includes the right to share in the profits of the business (the
financial interest) and the right to participate in the management of the
business (the management interest). In general and limited partnerships the
owners may freely transfer their financial interest but may not transfer their
management interest without the consent of all of the other owners. Corporations
allow a free transferability of entire ownership interest. Also, sole
proprietorships and general partnerships have a limited number of owners a
business can have.
Continuity of existence refers to duration of the business entity and whether it
can survive changes in ownership. Unless there are provisions to the contrary in
a partnership agreement, death or disagreement amongst the partners can result
in the dissolution of the partnership, which in turn necessitates renegotiating
contracts, filing a notice of the dissolution and a new partnership declaration,
entering into a new agreement and providing for new bank signing authorities.
The dislocation of a business on the death of a partner or a sole proprietor can
very serious. Corporations have high continuity and are not affected by the
death, bankruptcy, or withdrawal of owners and can elect to have perpetual
existence, subject to the statutory right of the owners to dissolve the business
at any time.
There are certain citizenship requirements for directors of corporations
incorporated under provincial and federal legislation. Ontario Business
Corporations Act (OBCA) requires a majority of the directors of a
corporation established in Ontario to be resident Canadians. In contrast
Canada Business Corporations Act (CBCA) provides that only 25% of the
directors need to be resident Canadians. Unless entrepreneurs are willing to
accept these citizenship requirements for directors, it will be necessary to
proceed by way of partnership or to incorporate in a province without such
citizenship requirement.
Finally, for high-tech start-ups another significant factor applies - potential
future financing. The types and sources of financing that will be used for a
business can impact its structure. If a business intends obtain financing
through common equity and simple debt funding such a business could be organized
as a limited partnership, whereas an incorporation will be required when
investors are given preferred equity interests. As discussed below, future
financing effectively limits the choice for entrepreneurs to incorporation. The
income trust is a new commercially accepted organization which must also be
considered.
2. Sole Proprietorships
The simplest form of business association is the sole proprietorship. A sole proprietorship exists
whenever an individual carries on business for individual’s own account without
using the medium of any other form of business organization or involving the
participation of other individuals, except as employees. The individual may
employ others in the business but cannot employ himself or herself. Any
liabilities that arise from tortiuous acts of the sole proprietor or employees
of the sole proprietor are the sole proprietor’s responsibility. All business
and personal assets of the sole proprietor may be seized in fulfillment of the
sole proprietor’s business obligations and liabilities, including debts incurred
by the sole proprietor in connection with the business.
The costs in establishing and running a sole proprietorship are minimal; it is
formed without any formality. The profits from the business are taxed to the
individual owner and filed on the individual's tax returns. Individuals are
taxed at progressive rates which, when combined with the tax rates imposed by
Ontario, reach maximum rate of 46.4%. The business is freely transferable by
sale, gift or will. Finally, the sole proprietorship may have a relatively short
life span because the death of the sole proprietor dissolves the sole
proprietorship. Typically, the sole proprietorship is used for small family
businesses.
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