By Jonathan Mackenzie
Tech entrepreneurs and IT Professionals generally have a great idea that they want to bring to the public. What stops many from being able to do this are the problems they encounter with actually growing the business itself. One thing you can do to prevent future headaches is to structure your business and understanding the tax consequences at the outset and create an organization that will meet your individual needs and goals. There are three common ways of organizing a business: sole proprietorship, partnership, and corporation. Which one is best for your business depends on a number of factors. Here we will be discussing the pros and cons of sole proprietorships and partnerships.
Sole Proprietorship
Sole proprietorships are the easiest and least expensive type of business organization to maintain. If you carry on business under your own name, you are actually carrying on business as a sole proprietorship. There are no formal registration requirements for a sole proprietorship unless it will be carrying on business under a name other than your own. In this case, you must register your business’ name with the Ministry of Government Services.
Because there are very few formalities associated with a sole proprietorship, it is a very nimble business format that can react quickly to changing circumstances. There are no shareholders, directors, or partners that must authorize various decisions. The consequence of this is that you, as the sole proprietor, are liable for all of the liabilities of the business. If your business goes into debt, your personal assets can be seized to satisfy this debt. The balance when deciding whether to use a sole proprietorship is between flexibility and security.
One reason some people prefer to operate as a sole proprietor is because all income and losses are attributable to the individual. All of the business’ income is meant to be reported on your personal tax return. Because of this, business losses can be used to offset any other gains you may have, resulting in a net tax savings. For example, if you are startup with lots of expenses at the start, and maybe you are married to someone who is working. With this type of structure, you can offset your expenses with their salary.
Tech entrepreneurs will likely want to avoid carrying on business as a sole proprietor when seeking investment because you will be using investors will want to invest money for equity in a company.
Partnership
When two or more persons, whether individuals, carry on business together with a view to profit, the relationship is called a partnership. A partnership is similar to a sole proprietorship in that it is relatively inexpensive to set up and there are few legal formalities required to create it. Like a sole proprietorship, all of the assets and liabilities of the partnership flow through to the people. Tax is calculated as if the partnership were a separate legal entity, and then the income and losses flow through to the partners in the proportion of their ownership. If you own 30 per cent of the partnership, you will need to pay income tax on 30 per cent of the partnership’s taxable income. Each partner can have their assets seized in satisfaction of the partnership’s debts.
Of particular interest to IT Professionals is the idea of a “limited partnership.” A limited partnership is one in which there are general partners and limited partners. A general partner is liable for any of the debts of the business. The limited partners’ liability is limited to the amount they have contributed or agreed to contribute. In this structure, you could bring someone on who shares in the profits of the business without being liable in the way that a general partner would be.
Service type of businesses may be drawn towards the partnership structure. Although, with the corporate tax rates as low as it is today, many lawyer sor accountants would be recommending against this structure for a corporate structure.
Jonathan MacKenzie is a lawyer specializing in civil litigation and corporate work with a special interest in small business and entrepreneurship.
October is small business month and to celebrate, writers from Aluvion Law will be making daily posts on one of the most common forms of Small Businesses: Corporations! Corporations are particularly popular among the high-tech and IT crowd because of the tax advantages they provide to rapidly growing companies, as well as the assistance they can provide in unlocking capital. The other great benefit recognized by the ‘serial entrepreneurs’ that flock to the IT sector is that they limit the liability of the owners in the event of the business failing.