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Sole Proprietorship, Partnership, or Corporation?

Posted on November 25 2015 | Author: Philippe Piche

Organizing a new business can be challenging as entrepreneurs are faced with many options on how to start their business. Choosing whether to establish  a sole proprietorship, partnership, or corporation is a common challenge for start-ups. The decision can have a significant impact on the business management of risks and tax exposure.

It’s important to first understand the different types of business structures. This will help entrepreneurs select the most appropriate structure for their business needs.

Sole Proprietorship
A sole proprietorship represents the situation in which an individual holds all the legal rights and responsibilities of their business activities. As such, the owner personally assumes the risks of the business activities including legal action and tax liability. The owner is responsible to declare business net income or losses as part of their personal tax reporting. For a start-up business, personal income tax rates can be higher than small corporation tax rates but start-up business losses can be offset against the owner’s other income. And legally, since there is no distinction made between the business and the owner, the owner’s personal assets are at risk if the business is not successful.

A partnership is similar to a sole proprietorship for legal and tax purposes, except that the business’ net income/losses, liabilities, and management decisions are shared between two or more individuals. Its similarity to a sole proprietorship model makes it relatively easy and inexpensive for business to start-up and operate.  Because liabilities and taxes are shared between the partners, it is considered less risky for entrepreneurs. But this also means that the partners share in management decisions, and can therefore create difficulties if the partners do not have the same vision.

A corporation is recognized by law as a single entity, or in other words, recognized legally as a person.  This takes much of the risk away from the owner's personal liability, as the company itself is now responsible for its debts and taxes.  While incorporating can reduce personal risks and taxes for the owner, it is more expensive to set-up and administer.  

There are different types of corporations that can either be private or public type corporations.  Private corporations are most commonly used among start-ups and owned by few shareholders, including the founders.  Public corporations sell shares of the company to the public through listings in stock exchanges. Listing through a public stock exchange makes it easier to access the financial markets by selling “shares” in the company. However, filing and reporting requirements for a public corporation can be considerable and expensive, whereas privately held corporations do not have the same disclosure requirements.

When starting a business, knowing the advantages/disadvantages of the different types of organizations (sole proprietorship, partnerships and corporations) can make choosing the right one an easier task. The entrepreneur's own situation and initial business prospects will be important criteria to the type of structure selected. The legal structure of a business is an important decision and should be based on the entrepreneur's budget, revenue, profits, expenses, size, and industry.

The most common business structure for a start-up is a sole proprietorship, which makes up 73% of all new small businesses (the rest being partnerships and corporations). Many start-ups are on a tight budget and may not be able to afford the costs and management requirements of a partnership or corporation.

Philippe Piche
Program Assistant

References: http://www.canadabusiness.ca/eng/page/2853/
Photo Credit: pixabay.com 

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