6.6: Choosing a Business Structure

The legal framework of a business, business structure or form of business ownership determines how the business is organized, who owns it, and how it is taxed. When starting your business, choose the business structure that best suits your needs. There are four types of business structures in Canada: sole proprietorships, partnerships, corporations and cooperatives.

Sole proprietorship

A sole proprietorship is a simple, unincorporated business owned and operated by one person. The owner has complete control, receives all profits, and is fully liable for the business’s financial and legal situation. A sole proprietorship is the easiest and most common way to start a business, but it does come with drawbacks, and all of the responsibility for the business’s success rests with you as the owner. Examples of sole proprietorship businesses include independent photographers, small landscaping companies, freelance writers, and personal trainers.

Partnership

A partnership is a non-incorporated business owned by two or more people who share profits, responsibilities, and risks.

A major problem with partnerships, as with sole proprietorships, is unlimited liability. In this case, each partner is personally liable not only for his or her own actions but also for the actions of all the partners. If your partner in an architectural firm makes a mistake that causes a structure to collapse, the loss your business incurs impacts you just as much as it would your partner. And here is the really bad news: if the business does not have the cash or other assets to cover losses, you can be personally sued for the amount owed. In other words, the party who suffered a loss because of the error can sue you and/or your partner for your personal assets. Many people are understandably reluctant to enter into partnerships because of unlimited liability. Certain forms of businesses allow owners to limit their liability. These include limited partnerships and corporations.

Partners are considered self-employed for tax purposes and have unlimited liability unless an LLP (limited liability partnership) is created. LLP allows partners to pool resources while limiting their liability for other partners’ professional negligence. Limited partnerships have at least one general partner who assumes unlimited liability, and at least one limited partner whose liability is limited to their investment in the business. Each Canadian province has its own partnership legislation, but all provinces recognize general partnerships and limited partnerships. Partners may have disagreements; therefore, a partnership agreement usually stipulates how decisions will be made, how responsibilities will be divided, and how profits will be split.

Partnership Agreement

The impact of disputes can be lessened if the partners have executed a well-planned partnership agreement that specifies everyone’s rights and responsibilities. The agreement might provide such details as the following:

• amount of cash and other contributions to be made by each partner
• division of partnership income (or loss)
• partner responsibilities — who does what
• conditions under which a partner can sell an interest in the company
• conditions for dissolving the partnership
• conditions for settling disputes

Corporation

A corporation is a separate legal entity from its shareholders and can be incorporated at the federal or provincial level. Corporations offer a flexible structure and the ability to divide ownership with shares. A corporation is a legal entity that separates the business from its owner/operator. Therefore, its shareholders have limited liability. Corporations can choose to incorporate federally or provincially.

Incorporation makes it possible for businesses to raise funds by selling stock. This is a big advantage as a company grows and needs more funds to operate and compete. Depending on its size and financial strength, the corporation also has an advantage over other forms of business in getting bank loans. An established corporation can borrow its own funds, but when a small business needs a loan, the bank usually requires that it be guaranteed by its owners.

Corporations are owned by shareholders who invest money in the business by buying shares of stock. Therefore, there is no ownership control by one person, unlike in a proprietorship. The portion of the corporation that the shareholders own depends on the percentage of stock they hold. For example, if a corporation has issued 100 shares of stock, and you own 30 shares, you own 30 percent of the company. The shareholders elect a board of directors, a group of people (primarily from outside the corporation) who are legally responsible for governing the corporation. The board oversees the major policies and decisions made by the corporation, sets goals and holds management accountable for achieving them, and hires and evaluates the top executive, generally called the CEO (chief executive officer). The board also approves the distribution of income to shareholders in the form of cash payments called dividends. Ownership can be transferred by selling shares and therefore is not dependent upon the life of the owner, board of directors or a specific shareholder.

Like sole proprietorships and partnerships, corporations have both positive and negative aspects. In sole proprietorships and partnerships, for instance, the individuals who own and manage a business are the same people. Corporate managers, however, don’t necessarily own stock, and shareholders don’t necessarily work for the company. This situation can be troublesome if the goals of the two groups differ significantly.

Managers, for example, are often more interested in career advancement than the overall profitability of the company. Shareholders might care more about profits without regard for the well-being of employees. This situation is known as the agency problem, a conflict of interest inherent in a relationship in which one party is supposed to act in the best interest of the other. It is often quite difficult to prevent self-interest from entering into these situations.

Another drawback to incorporation — one that often discourages small businesses from incorporating — is the fact that corporations are more costly to set up. When you combine filing and licensing fees with accounting and attorney fees, incorporating a business could set you back by $1,000 to $6,000 or more, depending on the size and scope of your business.^[1] Additionally, corporations are subject to levels of regulation and governmental oversight that can place a burden on small businesses. Finally, corporations are subject to what’s generally called “double taxation.” Corporations are taxed by the federal and provincial governments on their earnings. When these earnings are distributed as dividends, the shareholders pay taxes on these dividends. Corporate profits are thus taxed twice—the corporation pays the taxes the first time, and the shareholders pay the taxes the second time.

Co-operative (for-profit and not-for-profit)

A co-operative is controlled by its members and can operate for profit or as a not-for-profit. Co-ops are structured to meet the common needs of their members rather than maximize profits for shareholders. Just like a corporation, it can be registered provincially or federally, and each option comes with its own advantages and disadvantages. Some of the largest co-operatives in Canada include:^[2]

• Desjardins: The largest co-operative financial group in Canada.
• Sollio Co-operative Group: The largest agri-food co-operative in Canada.
• Federated Co-operatives: One of the largest companies in Canada.
• South Country Co-op: One of Canada’s largest co-ops.
• Vancity Co-op: Canada’s largest community credit union.

The co-operative is democratically controlled (one member, one vote). Ensures all members have input, but may result in slower decision-making.  All members need to participate for a co-op to be successful. Members receive special discounts, deals, education, training, services, and sometimes dividends. Surplus revenue is distributed back to the members, proportional to their use of the cooperative’s services. Members share in profits and losses, so they may be less willing to take risks or to invest in long-term projects.

Members contribute financially to the co-op by purchasing membership shares and using the co-op’s services. Members participate in the co-op’s governance by attending meetings, voting on major decisions, and electing the board of directors. Members follow the co-op’s bylaws and policies. Members offer suggestions on how to improve the co-op. Members volunteer some of their time and often serve on a committee. Therefore, all members need to participate for a co-op to be successful.

Business Structure Comparison

Refer to Table 6.1 for a comparison of the forms of business ownership.

Other Types of Business Ownership

When starting a new business, an entrepreneur must decide which choice is best for them when it comes to starting a business from scratch, buying a used business from another owner, or buying a franchise business. Each has its own benefits and drawbacks. Starting a business from scratch is ideal for innovators with a strong vision, risk tolerance, and creativity. Buying an existing business is best for those who want immediate operations and are comfortable managing an established system. Franchising is great for individuals seeking lower risk and structured support while operating under a recognized brand.

Franchising

A franchise is a business where the owner grants licenses to licensees to operate the business (sell its products, provide services, and more) at a business location. Think of Baskin-Robbins, CrossFit or another business that you’ve seen in multiple cities. Each location is a franchisee with its own management that pays a fee to the franchisor (the owner) to “rent” the brand name.

Below are the main financial elements of starting a franchise.^[3]

• Franchise purchase fee: This can cost anywhere from $20,000 to $50,000, depending on the license.
• Minimum liquid capital: A generally good idea is to have $50,000 to $60,000 for a service-based business, and $75,000 to $100,000 of liquid capital for a facilities-based business.
• Franchise royalties: This is a fee you’ll have to continue to pay to operate your business–the royalty fee can be 4% to 12% of your franchise location’s profits.
• Additional expenses: Franchise businesses also have expenses such as sourcing a commercial space (if applicable), staffing, and more.

Buying or Merging with an Existing Business

Given the stakes, it’s important to thoroughly weigh your business goals, risk tolerance and market opportunities before making an acquisition. To learn more about the pros and cons of buying an existing business, review this BDC article.

Acquisitions

A business acquisition is a financial transaction where one company buys the majority or all of another company’s shares or assets, giving the acquiring company control over the target company. Acquisitions are often amicable, with both companies agreeing to the terms of the deal. However, the term “acquisition” can also be used to describe a hostile takeover, where one company buys a majority stake against the wishes of the target company’s management or board of directors. A firm effectively gains control of a company if it buys more than 50% of a target company’s shares. Acquisitions are often carried out with the help of an investment bank because they’re complex arrangements with legal and tax ramifications.^[4]

An example of a business acquisition is Microsoft’s acquisition of Activision Blizzard for $68.7 billion in 2023. This deal brought popular gaming franchises like Call of Duty, World of Warcraft, and Candy Crush under Microsoft’s umbrella, significantly boosting its presence in the gaming industry. It also positioned Microsoft to compete more aggressively in the gaming market against rivals like Sony and expanded its potential in the growing metaverse and cloud gaming sectors.

Below are a few reasons for a company to acquire another company:^[5]

• Gain vertical integration. A business may want to buy its supplier or another business that is part of its supply chain to reduce costs and expand capabilities. Helps boost profits and make companies less dependent on their suppliers or distributors.
• Gain horizontal integration. A business strategy is one where one company takes over another that operates at the same level in an industry. Helps companies expand in size, diversify their product offerings, reduce competition, and expand into new markets.
• Enter a foreign market. Buying an existing company in another country could be the easiest way to enter a foreign market. The purchased business will already have its own personnel, a brand name, and other intangible assets. This could help to ensure that the acquiring company will start off in a new market with a solid base.
• Cost of expansion. Perhaps a company met with physical or logistical constraints or depleted its resources. It may be more cost-effective to acquire another firm rather than to expand its own operations. Such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit.
• Eliminate competition. Companies may start making acquisitions to reduce excess capacity, eliminate the competition, and focus on the most productive providers when there’s too much competition or supply. Federal watchdogs often keep an eye on deals that may affect the market. Acquisitions between two similar companies may harm consumers, including higher prices and lower-quality goods and services.
• Gain new technology. Sometimes it can be more cost-efficient for a company to purchase another company that has already implemented a new technology successfully than to spend the time and money to develop the new technology itself.
• Gain intellectual property. A company sometimes purchases another company to gain the other company’s intellectual property (i.e., trademarks, patents, copyrights, trade secrets).

Mergers

A company merger is when two or more companies join together to form a new company with a single stock. During a merger, the two companies negotiate terms such as the valuation of assets and the exchange ratio. While mergers are often thought of as an equal split, one company may end up with a larger percentage of ownership in the new company. Mergers are similar to acquisitions or takeovers, and the two actions are often grouped together as mergers and acquisitions (M&A).^[6]

Companies may merge for a number of reasons, including:^[7]

• Increase market share. Merging with another company may allow a company to gain a larger market share.
• Access new technologies. A company may seek a merger to gain access to new technologies, expertise, patents, or intellectual property.
• Gain economies of scale. By consolidating operations, a company can reduce redundancies and streamline processes, which can lead to improved profit margins.
• Diversify. A company can enter new markets or offer new products or services.
• Blend cultural values. A successful merger can lead to a more diverse and inclusive workforce.
• Enhance competitive position. A merger can strengthen a company’s portfolio or services and better equip it to meet the needs of consumers.

Strategic Alliances and Joint Ventures

A strategic alliance and a joint venture are both collaborative business arrangements between companies, but they differ in structure, commitment, and goals.

Strategic Alliance

A strategic alliance is a partnership between two or more businesses to work together on a common goal, while each company remains independent. The goal is to share resources and capabilities to create mutual value, such as by entering new markets, developing new products, or increasing innovation.

The other types of strategic alliances are equity strategic alliances and non-equity strategic alliances:

• Equity strategic alliance: One company buys equity in another company. This is also known as a partial acquisition.
• Non-equity strategic alliance: Two companies come together without exchanging equity. Each company brings its resources to the alliance. An example of a non-equity strategic alliance is the partnership between Starbucks and Indigo.

Joint Venture

A joint venture (JV) is a business collaboration in which two or more companies create a new, independent legal entity to achieve a specific business objective or undertake a particular project. In this arrangement, the companies share ownership, profits, risks, and governance of the newly formed entity. JVs often require substantial capital investment and a long-term commitment, typically concluding once the objective is met unless the parties agree to extend the venture.

Alternatively, a JV can also refer to a business agreement where two or more parties combine resources to pursue a common goal. These ventures leverage the strengths of each participant, often yielding mutual benefits. For example, a hairstylist and a nail salon might collaborate in a JV to attract more customers and increase profits. While JVs can adopt various legal structures, they are generally characterized by shared ownership, financial returns, risks, and decision-making authority. The terms of the JV are usually outlined in a private and confidential contract. A prevalent form of JV is the project-based joint venture, which dissolves upon the completion of the specified project.^[8]

There are two main ways of setting up a joint venture in Canada. The first is for the partners to agree on a contract that will set out the terms of the venture; the second is to form a separate corporate entity.^[9]

Below are a few advantages and disadvantages of joint ventures:^[10]

Advantages of a joint venture:

• Increased growth, productivity and profits
• Reduced costs and risks
• Growth opportunity that does not require having to borrow funds or look for outside investors
• Quick access to expertise

Disadvantages of a joint venture:

• Higher likelihood of conflicts arising
• Decreased control and flexibility through joint decision-making
• More widely shared knowledge, which can lead to sensitive information being communicated to other parties

Generally, the main difference between a joint venture and other types of strategic alliances is that a joint venture creates a separate legal entity, while a strategic alliance does not. For example, in 2022, these companies announced a joint venture to build a battery plant in Columbus, Ohio, to produce lithium-ion EV batteries for Honda’s electric vehicles.^[11]

An example of a joint venture is the one between Sony and Honda to create an electric vehicle. The joint venture, called “Afeela”, is a collaboration between the electronics company Sony and the automobile company Honda. The goal is to combine Sony’s expertise in imaging, networks, and entertainment with Honda’s skills in mobility development, technology, and sales. The company plans to take pre-orders in 2025 and deliver the vehicle in the U.S. in 2026.^[12]

Refer to Table 6.2 for key differences between strategic alliances and joint ventures.

Media Attributions

“A woman in a green hat and white shirt is standing in front of a building” by ZhiCheng Zhang, used under the Pexels license.

“Candy crush, Device, Electronics image” by Hemil Dhanani, used under the Pixabay license.