Our September, 2002  newsletter is entitled "Types Of Businesses."   Our newsletters feature articles on various aspects of preparing a business plan and over time should lead you through the entire business planning process.  

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Types Of Businesses

One of your first major decisions when starting up a new business is the form of legal entity it will take. This decision is influenced by the way you have organized your operations, and whether you intend to work independently or in conjunction with others.

The form of entity you choose can have a significant impact on the way you are protected under the law and the way you are affected by income tax rules and regulations. There are four basic forms of business organizations, each having its own benefits and drawbacks. They are:

• Sole proprietorship
• Partnership
• Corporation
• Cooperative

Sole Proprietorship
Sole proprietorship is the most common form of small business, particularly for those in the early stages of development. It is typically a business owned and operated by one individual who has complete control over its conduct and management. A sole proprietorship is not considered to be a legal entity, but rather is an extension of the individual who owns it.

In some situations, a sole proprietorship is operated by a husband and wife. In this case, the spouse who is not considered the proprietor, is treated as an employee.

The sole proprietor has possession of the business assets and is directly responsible for the debts and other liabilities incurred by the business.

All the income or loss of a sole proprietorship is considered to be the income or loss of the sole proprietor.

Advantages of a Sole Proprietorship

• It is the easiest and least expensive form of business to own and operate because it does not require any specific legal organization, except of course, the normal requirements such as licenses, permits and registering with tax authorities.
• It typically does not have any rules or operating regulations under which it must function. The business decisions are solely the result of the owner's abilities.

Disadvantages of a Sole Proprietorship

• The major disadvantage of sole proprietorship is that the owner is legally liable for all debts and actions taken against the business.
• Sole proprietorships have a limited ability to raise capital and are limited by the resources of the owner. Usually, as sole proprietorships begin to grow and expand, they become incorporated.

Partnerships
A partnership can take two legal forms, general and limited.

In a general partnership, two or more individuals join together to run the business enterprise. Each of the individual partners has ownership of company assets and responsibility for liabilities, as well as authority in running the business. Usually the partners are jointly responsible for all debts of the partnership. The authority of the partners, and the way in which profits or losses can be shared, is usually set out in a partnership agreement.

A limited partnership is comprised of:

• General partners, who are personally liable for the partnership debts, and
• Limited partners, who contribute capital and share in the profits or losses of the business, but do not take a part running the business and are not liable for the debts.

Limited partnerships are usually established in situations where a considerable amount of capital must be raised. The limited partners contribute capital and share in the profits or losses, but they have no legal liability beyond their investment. The general partner(s) operate the company and are liable for the debts of the business.

In most partnerships, general and limited, the rights, responsibilities and obligations of all the partners are detailed in a partnership agreement. The agreement is very important especially since many partnerships fail because of disagreement among the partners about issues that should have been covered in the agreement.

A partnership does not file a tax return, but each individual partner is responsible for claiming his or her share of the partnership income or loss on their personal tax return.

Advantages and Disadvantages of Partnerships
The major advantages of partnerships are the benefits derived from pooling the skills of two or more individuals and the increased ability to raise capital.

The major disadvantage of partnerships is that the partners are legally liable for the debts of the business, with the exception of limited partnerships where the limited partners are only liable for their investment. Also, individual partners are not running their own business. They may have to compromise with the other partners in certain situations.

Corporation
A corporation is a separate legal entity. It is distinct from its owners and exists under the authority granted by provincial law. It has all of the legal rights of an individual and is responsible for its own debts. It must file its own income tax return and pay taxes on income it derives from its operations.

Advantages of Incorporating
Usually the owners, or shareholders, of a corporation are protected from the liabilities of the business. However, when a corporation is small, major creditors will often request personal guarantees from the principal owners before extending credit.

There are other advantages to incorporating:

• Additional capital can be raised through the sale of shares or by the transfer of assets to a corporation.
• It provides for business continuity when the original owners choose to retire or sell their interest, or if the original owner should suddenly die.
• There are opportunities for family members for tax and estate planning.

Disadvantages of Incorporating
The major disadvantage of a corporation is the additional costs involved with starting and administering a corporation. Initially, it may cost over $1,000 in legal and regulatory fees to form a corporation. Corporations also incur annual filing costs. Corporations must file income tax returns each year. This usually results in additional accounting fees.

However, the legal protection afforded the owners of a corporation can far outweigh the additional costs of incorporating. With the exception of small, owner-operated businesses with few employees, it is usually recommended that the business incorporate so that the owners have protection from business liabilities.

• A cooperative is organized and operated for the purpose of providing its members with goods and services.
• Regardless of the number of shares a member has, no member has more than one vote.
• The return on capital investment to the members is limited by legislation.
• Any surplus is usually returned to the members in the form of patronage dividends. Each member receives a share of that surplus in proportion to the amount of business done by the member with or through the cooperative.

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