Starting a new business, especially your first business, can be an exciting and rewarding experience. Still, it can be not very clear for first-time entrepreneurs to determine if they have the appropriate legal structure for their business.
Two of the most common business entities are corporations and sole proprietorships. Both have advantages and disadvantages, so it’s essential to consider which structure best suits your circumstances before setting up shop. This article will explore the differences between a corporation and a sole proprietorship to help you decide how to form your business.
If you have a sole proprietorship, you own and operate the business. Therefore, all profits and losses of the company go directly to you, the owner.
On the other hand, a corporation is a legal entity on its own. A corporation is a complex legal structure that separates the owners from the company. The corporation earns money, and typically business owners take a salary or dividend to pay themselves.
Pros and Cons of a Sole Proprietorship
Sole proprietorships are the most straightforward legal structures. In general, they offer simplicity but at the risk of personal liability.
Pros of a Sole Proprietorship
A sole proprietorship is the simplest form of business structure and often requires minimal paperwork to set up. In Canada, you can register a business name, operate under your name, or both.
Low Startup Costs
Since no additional fees are associated with setting up a sole proprietorship, it’s usually the least expensive type of business entity.
Cons of a Sole Proprietorship
In a sole proprietorship, there is no legal separation between your assets and the business’s assets. As the only owner of a company, you will be personally liable for any claims, debts or obligations that the company has. Your personal assets could be at risk if a lawsuit or other legal action is filed against your business.
Lack of Continuity
A sole proprietorship does not have an ongoing existence. Therefore, you cannot transfer ownership of the business if you choose to stop.
Pros and Cons of a Corporation
Pros of a Corporation
Protection from Personal Liability
The primary benefit of a corporation is that it protects the owners from personal liability for the business’s debts and obligations. As a result, creditors cannot come after your personal savings or other assets if the company gets into financial trouble.
Easier to Change the Capital Structure
Another benefit of a corporate structure is that it’s easier to add on investors or sell shares to employees.
A corporation is its legal entity. If you need additional capital or want to offer stock options to attract and retain top talent, the structure can be beneficial to have in place.
Corporations may also take advantage of certain tax benefits, depending on the structure and size of the business.
Cons of a Corporation
The biggest downside of forming a corporation is the costs associated with doing so. Setting up and maintaining a corporation can be significantly more expensive than setting up and operating a sole proprietorship.
Additionally, corporations have more administrative requirements than sole proprietorships. Administrative tasks for corporations include filing incorporation documents with the government and preparing additional tax forms.
When deciding whether to form a corporation or remain a sole proprietorship, it’s essential to consider the pros and cons. The best structure will depend on your individual business needs and goals. Generally, forming a corporation may be the right choice if you seek personal liability protection, greater access to capital, and potential tax benefits. On the other hand, the simple structure of a sole proprietorship, with low startup costs and minimal paperwork, maybe the best choice for your business.
Size or stage of your business
The size and stage of your business will also play a role in determining which structure is appropriate for you. For example, sole proprietorships are generally best for small businesses with limited capital.
Access to Capital
With a sole proprietorship, you cannot sell shares in your business. As a legal entity, a corporation allows you to raise capital by issuing shares. A corporation might be the better choice if you’re looking to access outside investment or raise funds. The structure will already be in place when you need it.
Potential risk and liability
You should also consider any potential risk and liability associated with your business. If you operate in a high-risk industry where legal or financial issues are likely, forming a corporation may be a better option as it offers liability protection for the owner’s assets outside the corporation.
Tax Structure and Administrative Burden
It’s important to consider potential tax implications when choosing a suitable business structure. While corporations may benefit from certain tax advantages, but they can be expensive. In some cases, these costs outweigh the benefits. Your accountant can help you determine whether incorporating your business will be worthwhile.
As a business owner, deciding whether to structure as a sole proprietorship or a corporation is an important decision that should be made thoughtfully. Consider your business goals, size and stage of development, access to capital, and potential risk and liability before deciding.
While there is no one-size-fits-all solution when choosing the proper structure for your business, understanding the pros and cons of each can help you make an informed decision that will benefit your business in the long run.
At KSSP Partners LLP, our experienced Chartered Professional Accountants provide modern accounting and tax solutions to meet the needs of your new or growing business. Whether you are a new business or looking to ensure you have the proper business structure, our knowledgeable and experienced accounting team at KSSP Partners LLP can provide clients in Markham, Toronto and across Ontario with innovative accounting and tax solutions. To learn how we can help you and your business with all your accounting and tax needs, contact us online or by telephone at 289-554-5997.