Restructuring Your Business

The structure used when a business first starts out is not always the best structure as the business grows.  Different legal implications arise from each type of business structure. A sole proprietorship is an unincorporated business owned by one person.  The owner has complete control over the business, and receives all of the profits, but is personally liable for all the debts and liabilities of the business.  The liability extends even to personal property and assets. A partnership is also an unincorporated business but there are two or more owners/partners.  A partnership agreement is entered into to define the management responsibilities, interests in the business, and allocation of profits for each partner.  Each partner is jointly and severally liable for the debts of the partnership. Another type of business structure is a corporation.  A corporation is a separate and distinct legal entity.  Ownership of a corporation is through the ownership of shares and its capital stock and shareholders are not responsible for the corporation’s debts. These are three of the most common business structures in Ontario.  An unincorporated business is easy to set up and less expensive, there are minimal regulatory requirements, there are lower ongoing legal and accounting fees and generally, business losses are deductible from the owners/partners taxable income from other sources.  However, with an unincorporated business, there is unlimited personal financial liability on the part of the owners/partners in the event of bankruptcy or judgment against the business.  An unincorporated business cannot use certain tax advantages, income deferral opportunities or income splitting opportunities that are available to incorporated businesses. Whatever structure you use in the beginning will likely evolve and change over time as your business grows, your liabilities increase, and your needs change.  All businesses must adapt and adjust to changes in business conditions in their sector.  Successful businesses are ones that can easily adapt to a change in conditions. It is important to identify those changes in your business that trigger a need to restructure. A key form of restructuring for a sole proprietor is to incorporate the business.  All assets of the business would be transferred from the sole proprietor to the new corporation.  The corporation could be owned 100% by the sole proprietor or more shareholders could invest in the company. Another change a sole proprietor might make is to bring on a new partner or merge with another business.  There are two aspects that need to be considered.  First, the business owner should assess the business model to determine whether the two partners or two businesses work better together than they do individually.  Second, legal matters should also be addressed, usually in the form of a partnership agreement or a shareholders’ agreement.  The key concepts in these agreement are similar. A partnership or shareholders’ agreement should define the business, the skills, and the contribution whether in finances, client lists, or expertise that each partner/shareholder brings to the expanded business. The agreement should also provide for joint decisions on key matters such as salaries, dividends, payments of substantial contracts, entering into new business, the authority to bind the company.  A mechanism for dissolving the partnership or shareholders’ agreement should also be included. Another business structure includes the use of a holding company.  The holding company could own shares in the operating business and retain funds and other investments.  This is a way to possibly reduce/defer taxes and further limit liabilities. In addition to obtaining legal advice, it is important to also get advice from an accountant on the restructuring.  There are steps that can be taken in order to minimize tax consequences. There are many triggers that can lead to restructuring a business and it is crucial to identify and act on them at the right time.