Business structure

Incorporation is usually undertaken for one or both of two reasons: Tax minimization, and liability protection. Regarding taxation, a proprietorship's income is taxed as if it was the proprietor's personal income. Therefore, if that income is high enough, personal taxes can be relieved by establishing the company as a separate entity that pays its own taxes and qualifies for (usually) lower taxation rates.

If your company produces a product or service in which financial and other liability may become a factor, incorporation offers the company's principals some protection from that liability.

Selection of a year-end usually involves examination of a business' income rhythms and the consequent choosing of the appropriate year-end that will maximize tax advantages. Most smaller companies choose the calendar year end as a corporate year-end because it is not worthwhile to choose another one.

You should talk about this and other issues to an accountant who will be more conversant with your own particular situation. However, you can find more general information on incorporation at www.cbsc.org, and at www.corporationcentre.ca.

• The purpose of the joint venture (and why it may be more appropriate form than an informal alliance).
• Whether the venture is for a specific period of time or indefinite.
• The resources and value to be dedicated to the venture by the participants.
• The goodness of fit between the participating companies.
• The control mechanisms of the company.
• The specific responsibilities of the participants.
• Specific goals for the venture.
• Potential impact to your present business reputation.
• How you will handle cash calls and personal guarantees if required, etc.

• Sole proprietorship
• Partnership
• Incorporation

Q. What is the level of liability between sole entrepreneur and an incorporated business. If incorporated is the owner held personally liable if business fails?

A. The question of whether a business should operate as a sole proprietorship (or partnership) or as a corporation is largely a tax issue, because incorporation allows some manipulation of tax rules for both the business and the owner.

In a sole proprietorship, the business owner(s) is responsible for all aspects of the company's financial dealings – in essence the company's money is the owner's money and vice-versa. If the business fails, the owner is personally responsible for all its financial liabilities.

Incorporation involves the creation of a legal entity with financials that are separate from those of the owner or owners. The corporation – not the owner -- takes out loans, pays bills, takes in revenue, pays the owner a managerial salary, etc. If the business fails, the corporation, not the owner, is responsible.

However, another aspect of the sole proprietorship or incorporation question involves liability, but this is less clear than the taxation aspect. Essentially, because an incorporated business is an entity onto itself, its liabilities fall within the corporation's purview, and not that of the owners.

Therefore if the business fails, the corporation that governs it can declare bankruptcy and absolve itself (and its owners) of any financial liability. Also, some businesses engaging in high-risk activities (that may have an impact on the environment, for example), incorporate so that liability growing out of lawsuits and regulatory problems falls on the company and not on the owners. From a liability point of view, incorporation with its separation of responsibilities is always better than sole proprietorship, where personal and business responsibilities are mixed.

However, this is not an absolute shield from all kinds of liability all the time. Lenders often require that owners or shareholders put up personal assets, such as houses, as collateral for loans. These are usually then charged to the corporation as shareholder loans to the company. If the business fails, the owners will still be on the hook because the loans are personal, not corporate.

Another aspect to the question involves revenue and costs. Incorporation involves some legal costs, which can vary depending on how the incorporation is undertaken. Also, there are ongoing costs – the company's financial statements must be audited annually, and there is a reporting regime in place that adds to these costs. With a sole proprietorship, this is more simplified and therefore more cost-effective: the sole proprietor includes all business aspects in his or her annual personal income tax statement. That is why most advisors suggest that a business should be earning at least $50,000 in revenue annually to justify the costs of incorporation.

Q. What licenses and personal insurances do I need to start a part time consulting business from my home?

A. Advances in communications technology and the growth of knowledge-based business have allowed thousands of businesses to begin in the homes of business operators. In fact most businesses today start in a home, often as part time ventures that allow the operator to "ease into" self-employment.

But, while it is easy to start a home based business, it must be treated in a business-like manner and not just as some hobby. This involves business management procedures such as maintaining accounts, structural organization, maintenance of a physical setting, and other operations – just as if the business was operating out of a rented office space.

One of these procedures involves compliance with all municipal, provincial and federal regulations regarding taxation, licensing and other regulatory regimes. However, when it comes to licensing, the situation becomes more clouded. Federal and provincial governments are not concerned with licensing – except in some special situations such as telecommunications delivery. Municipal governments are, however, because business licensing forms an essential part of their tax base and governance of the community.

This is where the cloudiness comes in. Most municipalities forbid home business – although this is beginning to change -- because in the past it has been disruptive to the community. Operating a print shop, a vehicle repair operation, or a manufacturing situation at home generates increased traffic, waste, noise, and other nuisances to neighbors. However, any business involving knowledge work, "virtual" organizations, and communication falls into a gray area because it is essentially hidden and is therefore rarely enforceable.

A rule of thumb is that if your business involves bringing clients to your home, or requires advertising and signage then you should obtain a business license, which may or may not be allowed, depending on the zoning of the area in which you live. If it involves visiting clients on site, or working quietly at home in a non-manufacturing setting, then municipalities tend to ignore the licensing requirement because it is not disruptive.

Insurance is a risk-management, not a regulatory, issue. There is no law that requires a business to have insurance, unless it has the potential to be hazardous to others in the community. Consultants, accountants, creative workers, and others who often work from home must look at the insurance question from a risk point of view. Generally, business insurance is only purchased if there is some potential for catastrophic loss that cannot be covered by revenue– such as a massive business liability.

However, anyone working at home likely has some equipment and other physical assets that should be insured in case of loss. This becomes an issue with your home insurance provider. Most will not cover business assets as part of a personal homeowner policy. But most will also add a low-cost rider to a homeowner policy to cover business assets such as computers, etc. It is a good idea when starting a business in the home, to notify your home insurer and pay the relatively minor cost of insuring your business assets.

Q. I'm developing a new product that requires R&D. I'm not sure what the first steps is - create a beta version and build the business around it or start a business and then develop the product.

A.A business is an organization formed to produce and sell a product or service. Creation of a business structure allows a product or service developer to begin studying potential markets, devise strategies to gain access to customers, and determine whether the product or service will match the market's needs.

In fact, understanding the market will probably help in the R&D process, since the product or service may have to be shaped to better fit market requirements. Also, in terms of product development in the technology area, a business structure positions the developer for access to federal and provincial research and development tax subsidies.

Therefore, create the business first, then develop the product. Both tasks can be performed at the same time, of course.

Q. I have registered a business as a sole proprietor for an ABC Management Services. I want to help my daughter set up a small retail store. I have found a property with rental apartments above. What would be the best way to set up the structure? Should I incorporate the management services company as a holding company and lease out the space to the retail business? What are the advantages, disadvantages of doing this?

A. This is a broad-based question of strategy that involves business implementation aspects that can best be addressed by an accountant or tax lawyer. However, I will discuss it from a broad viewpoint.

There appear to be two issues here: One involves your business strategy and the other your business structure. The first issue governs the second.

Regarding your strategy:
Your question implies that you created your company to help your daughter set up a small retail store. If this was indeed its sole purpose, your strategic options are limited; if your daughter's retail store is one of several spaces you will be renting then you have other options.

First you must determine what your business truly is, and what its purpose is. If it is to buy a building, and support your daughter's business with rents from adjoining apartments, then you are involved in the property management or commercial real estate business. If you merely want to rent or buy the building in order to supply your daughter with a location, then you are involved in retail management -- in essence you are the retailer. Each business has its unique characteristics, problems, and strategies.

Regarding your structure:
If your business is the former, property management, and from the sounds of it, it is, you should consider several factors, including opportunity costs, overhead, return on investment, taxation, and profit. For example, after determining your initial costs of purchase and forming a projected cash flow analysis, you could, as you suggested, lease the space to your daughter, presumably at a loss, which may or may not be covered from apartment rentals. This would be a more arms-length structure.

On the other hand, you could nominally operate the retail business yourself (as owner) and have your daughter manage it, which would make the store and the building that contains it more of a family business. This would allow you to run a loss for a period of time.

As regards incorporation vs. sole proprietorship: Generally you must think of two factors —liability and taxation. When you are a sole proprietor, tax authorities consider the business' money as your money and vice-versa. Therefore, if you have another source of income (a job, for example) you can apply business losses to that income and generate tax deductions. However, there must be an eventual promise of profit or tax authorities will disallow the loss. This is often a viable option in the early years of a business when losses are common.

Incorporation is a different structure altogether. When you incorporate, you are creating an entity separate from yourself that pays its own expenses, its own taxes, retains its own profits if there are any and might or might not pay you a salary as CEO. After a certain point of income, these business taxes can be much lower than the personal taxes you would pay if you remain as a sole proprietor, and you also have more flexibility regarding your own income. Also, incorporation offers some limited liability protection in that you will not be personally responsible for the company's debts as you would be as a sole proprietor. Lastly, corporations can run losses for several years, while sole proprietors cannot. Indeed, it is not uncommon for one company to buy another merely to obtain the tax benefits of accumulated losses. On the other hand, it is more costly to operate a corporation because there are strict reporting and governance rules that must be adhered to. That is why most companies do not incorporate until they have reached a certain point of income.