Should I incorporate? The best manner of carrying on business.

Individuals will often seek the advice of legal counsel, accountants and financial planners on the best manner of carrying on a business.

The choice of which business type to choose will depend on a number of a factors. Here is a non-exhaustive list of some of the factors a lawyer may advise a client to consider:

  1. What method of carrying on business are legally possible
  2. Liability considerations
  3. Desire for perpetual existence
  4. Tax and estate planning
  5. Number of individual proprietors
  6. The relationship of the proposed proprietors
  7. The relationship between the business and employees
  8. The costs required
  9. Citizenship requirements
  10. Flexibility of structure

We will explore a few of these considerations below.

What method of carrying on business are legally possible

A lawyer will first consider what forms of business vehicle are legally possible for the business. For example, only an individual (i.e. not a corporation) can carry on business as a sole proprietor. A lawyer will not be able to recommend a corporation carry on business as a sole proprietor. A business may not qualify for registration as a charity or not-for-profit and therefore these forms of carrying on business may be legally precluded from consideration. Moreover, there may be limitations to incorporation in certain jurisdictions if there are certain citizen or residency requirements for directors or incorporators.

Liability considerations

A corporation, being a separate and distinct legal entity from its shareholders/owners, will itself, rather than its shareholders, be liable for debts and other obligations. A shareholder, cannot be bound to the debts and obligations of the company. To be sure, this is subject to some qualifications, such as on consent or situations of fraud, but these are the exceptions, not the rule. Conversely, most partners in a partnership and sole-proprietors, for example, will be liable to creditors and other debts of the business. This liability extends to the personal assets of the proprietor or or partner.

Some proprietors or partners will safeguard themselves against this risk by obtaining insurance. If liability insurance does not substantially cover the potential risk, than a business owner may be assuaged to incorporate on account of the liability risk alone.

Perpetual existence

A corporation does not rely on the survival of the individual shareholders for its existence. A corporation, being a separate legal entity, but lacking the characteristic of human mortality, thus benefits from perpetual existence.

A partnership or proprietorship, except in the place of proper planning or agreements to the contrary, may cease to exist upon the death or disagreement of the partners.

Tax and estate planning

The flexibility of share structure and classes of a corporation will allow a proprietor to direct the financial benefits of the business to family members or other third parties while still maintaining the controlling mind of the corporation.

The full picture of this share structure should be found in a well maintained corporate minute book or corporate record book. This book will ordinarily contain the shareholder ledger, which tracks the distribution, trade and redemption of shares issued by a corporation. The minute book will also contain original and certified copies of share certificates that have been issued. You should also be able to locate by-laws of the company and resolutions of the directors, which may further evidence the structure of the company.

Citizenship requirements

Every jurisdiction will have its own set of rules and requirements relating to citizenship and the corporation. For example, citizenship requirements can be found in Ontario’s Business Corporations Act (OBCA) and in the Canada Business Corporations Act (CBCA).

Section 118 of the OBCA sets out the qualifications of directors and under subsection (3) states,

Residency

(3) At least 25 per cent of the directors of a corporation other than a non-resident corporation shall be resident Canadians, but where a corporation has less than four directors, at least one director shall be a resident Canadian.

If no resident Canadian owners wish to incorporate in Ontario, a lawyer may advise to appoint at least one Canadian director and then have the shareholders execute a unanimous shareholder’s agreement (USA), which has the effect of giving all the controlling power of the company back to the shareholders. This, in effect, satisfies the director requirements and allows for the company to be in compliance with the OBCA whilst avoiding the need to find a resident business partner. In fact, section 118 (2) of the OBCA even states that a director does not need to be a shareholder in a corporation.