5 Key Factors in Choosing a Business Structure

Starting a business is an exciting venture that gives you freedom over your schedule, the opportunity to profit from your efforts, and allows you to offer valuable services or products to your community. At the same time, your business demands certain responsibilities, such as paying taxes to the Canada Revenue Agency or taking on liability risks. In this article, we’ll weigh the pros and cons of each business structure option in Canada: sole proprietorship, corporation, partnership, and co-operative based on 5 key factors.

Types of Business Structures

There are four types of legal business structures in Canada:

Sole Proprietorship: A sole proprietorship is the simplest business structure, owned and operated by one individual. The owner has full control over decisions but is personally liable for all business debts and obligations. Income is reported on the owner’s personal tax return, making it straightforward but with limited legal separation from the business. In this case, the business invoices under their own personal name.

Partnership: A partnership involves two or more individuals or entities sharing ownership of a business. Partners share profits, losses, and responsibilities based on a partnership agreement. There are two main types: general partnerships, where all partners have equal liability, and limited partnerships, where some partners have limited liability.

Corporation: A corporation is a separate legal entity from its owners, providing limited liability protection. It is more complex to set up and operate, with specific legal and tax obligations. Corporations can raise funds by issuing shares and are taxed separately from their shareholders, who report dividends or income received on their personal tax returns.

Co-Operative: A co-operative is a business owned and operated by a group of individuals or organizations with a shared goal. Each member has an equal say in decisions, regardless of their investment size. Co-operatives are typically designed to benefit their members rather than generate profit, with profits often distributed based on member participation. This type of business structure is quite rare.

Factor #1: Liability

The first factor to consider is whether or not your business will require liability insurance. Business insurance is not mandatory in Canada, but it is good to have if your business may be held liable for the products or services it provides. Businesses in manufacturing, the food industry, the trades, and even professional services have operations that would benefit from insurance. For example, a psychologist offering professional advice that leads to an individual harming themself, or a tradesperson offering a service that results in a client’s injury are two situations where professional liability insurance would be beneficial.

Your liability risk is important in considering your business structure because certain structures protect the business owner, while others do not. Corporations and co-operatives give the business owner limited liability, meaning that if an individual sues the business, the personal property and assets of the individual business owner(s) are not at risk. However, the structure of sole proprietorships and partnerships are such that the business owner(s)’ personal assets are at risk if the business is held liable for damages. If you think business liability may be a concern, opt for a corporation or co-operative.

Factor #2: Tax Deferral

The next factor to consider is how much taxes the business will pay, which is determined by your anticipated annual profit (not revenue).

For example, a business based in Ontario that earns $200,000 in profit would be better off being incorporated, as their tax burden would be less than that of a sole proprietorship, partnership, or co-operative.

Sole Proprietorship/Partnership:

Corporation:

With the corporation, you have the option to leave a portion of the profits in the business, whereas with a sole proprietorship, all of the profits directly go to you since you are indistinguishable from the business. When you leave money in the business, it is taxed at the corporate tax rate which is lower than the personal income tax rates. You also have the option to take the remaining profits in the corporation and invest in stock, bonds, or mutual funds directly through the business.

We find the tipping point for this tax deferral benefit is at about $100,000 in profit. At this point, you are able to save money in your corporation, and the tax savings will far exceed the incorporation fees and annual tax filing and accounting fees.

Bonus Tip: All businesses must register for an “RT” number with the CRA to report GST or HST once annual revenue reaches $30,000. This is the same for every business, no matter the structure or industry.

Factor #3: Who Is Involved

Choosing the right business structure requires careful consideration of who will be involved in the business, as this can significantly impact operational dynamics, legal responsibilities, and tax strategies. The level of involvement also matters—whether individuals are active participants or silent investors will influence liability and control. It’s important to consider how the roles and relationships of those involved relate to certain legal and tax implications, as they will affect day-to-day operations and financial outcomes.

If you are choosing to run your business democratically where all members have an equal say, a co-operative may be ideal. This is a rare business structure, but works well for non-profit organizations as well as some businesses whose goal is to meet the needs of the members rather than maximize profits.

On the other hand, if you plan to involve family members or partners, structures like a corporation or partnership might allow for income splitting, reducing the overall tax burden by distributing income among multiple people.

Income splitting is a tax strategy that reduces an individual’s tax bill by transferring income to lower-income family members. Read our article, Income Splitting Ideas For Business Owners to learn more about the ways to minimize your tax bill as a business owner.

For now, let’s look at one example where Catherine and John are both shareholders in the textile business that is incorporated.

If you choose to split your income, you will need to make sure that you comply with the TOSI (Tax on Income Split) rules.

On the other hand, if Catherine and John are the two stakeholders in a partnership, their tax calculation would look like this:

Rather than being taxed on dividends or cash distributions, Catherine and John as partners would be taxed on profits allocated to them for the year.

Carefully assessing who will be involved in your business and their roles ensures your chosen structure supports not only legal and tax compliance but also long-term growth and collaboration.

Factor #4: Optics

Another consideration is how you would like the business to appear to customers. The business structure you choose can influence how your business is perceived by the public, vendors, and clients. For instance, incorporating as a corporation often conveys a sense of professionalism, stability, and credibility, which can be appealing to clients and partners.

On the other hand, a sole proprietorship may signal a more personal, hands-on approach, which some customers value. Partnerships and co-operatives can showcase collaboration and shared values, which might resonate with vendors and clients prioritizing community or teamwork. Your structure should reflect not only how you operate internally but also how you want to be viewed externally, as this can impact trust, reputation, and your ability to attract business opportunities.

Factor #5: Business Loans

The final factor to consider when choosing a business structure is whether you plan to apply for a bank or business loan. Lenders often view corporations as more favorable borrowers because they offer liability protection and appear more stable and credible. Corporations typically have an established framework for separating personal and business finances, which can make it easier to assess risk and ensure repayment.

Alternatively, sole proprietorships and partnerships may face greater scrutiny, as the lack of liability protection increases the lender’s risk. Additionally, corporations can issue shares to raise capital, providing another avenue for securing funding. When considering financing options for growth or operations, the business structure can significantly influence not only your eligibility but also the terms and conditions of any potential loans.

Making The Right Choice

Choosing the right business structure is a critical decision that will affect your business’s operations, legal liabilities, tax strategies, and even how it is perceived by clients and potential partners. Whether you’re running a solo operation, partnering with others, or building a corporation, understanding the key factors listed above will help you make the best choice for your unique needs and goals. As your business grows and evolves, your structure can adapt, but starting with the right foundation ensures long-term success and financial efficiency.