Advice from our Québec City and Lévis lawyers in Quebec business law: set up your business in the legal form best suited to your business goals.
In Quebec, many terms are used in everyday language to refer to a for-profit business: company, corporation, incorporation, small and medium-sized enterprise (SME), partnership, sole proprietorship, self-employed worker, etc. However, these terms are often used incorrectly, because they do not all refer to the same legal form of business. Choosing a business’s legal form is extremely important, since each form has specific features that must fit the business’s situation and the entrepreneur’s goals.
Before thinking about the right legal form, it is important to structure the steps of the business project so as to avoid wasting time and money. To do this, the business project must be clearly defined. Turning a business idea into reality requires detailed planning, particularly regarding management, marketing, day-to-day operations and the financial framework. So take the time to write a business plan.
Do not underestimate the importance of this step, especially when the business needs financing from various organizations or financial institutions. Once the business plan is complete, the project is well defined and any business partners are better able to move in the same direction, sharing a common vision and goals.
As part of this first step, it will become relevant to consider which legal form of business to adopt. Here is a brief overview of the three main legal forms available to entrepreneurs who want to set up a for-profit business.
1. Sole proprietorship
As its name suggests, a sole proprietorship can belong to only one person. The entrepreneur and the business are one and the same, even if the business operates under a name other than its owner’s.
This legal form has the advantage of being the least expensive to set up and requires a minimum of formalities. The only formality required is registration in the enterprise register (Registre des entreprises), and only if the entrepreneur operates under a name other than their own first and last name.
However, a sole proprietorship can have certain disadvantages. First, the entrepreneur bears all the risks of the business and is personally liable to all creditors. Their personal assets serve as security for their creditors and may eventually be seized. Finally, from a tax point of view, a sole proprietorship can be less advantageous than a business corporation, for example if the entrepreneur wants to reinvest profits in the business. That said, if the business has a tax loss, it can be deducted from all of the entrepreneur’s income.
2. Contractual partnership (or “partnership”)
Contractual partnerships include the limited partnership (S.E.C. / L.P.), the undeclared partnership (S.P.) and the general partnership (S.E.N.C. / G.P.). The general partnership is the most common type of partnership, so it is worth outlining its main features.
2.1 General partnership (S.E.N.C. / G.P.)
This is an option to consider when several entrepreneurs want to operate a business together in a spirit of cooperation, in order to make and share profits and losses.
In this context, they pool their resources and set out by contract the terms of their partnership and the internal management rules of their business. It is this contract, called a “partnership agreement” or “contract of partnership,” that creates the general partnership, and it then becomes the law between the parties.
This legal form of business is simpler than a business corporation. The partners have a lot of flexibility to set out by contract how their business will operate internally. In addition, a contractual partnership is inexpensive, since it involves few government fees and few professional fees, such as those of lawyers and accountants.
From a tax point of view, the partnership’s income is considered the partners’ personal income. As with a sole proprietorship, this legal form can therefore be more or less advantageous depending, in particular, on the income the business generates and whether the partners intend to reinvest it in the business.
On the other hand, a general partnership has certain features that may turn out to be disadvantages. Unlike a sole proprietorship, a contractual partnership requires a written contract, usually drafted by a lawyer, whose cost varies depending on the complexity of the activities carried out. Also unlike a sole proprietorship, a contractual partnership must register in the enterprise register (Registre des entreprises). The partners must therefore handle certain formalities. Finally, each partner is answerable for their own acts and those of their partners. They can therefore be held liable for all of the partnership’s debts and put their personal assets at risk.
3. Business corporation
A business corporation, also called a company or corporation, is used in the business world when the goal is to make a profit. It is a legal person, meaning an entity that is legally separate from its officers and owners. It is owned by those who hold its shares, commonly called “shareholders.”
The shareholders’ personal liability for the business’s debts is limited to the value of their shares. As a result, they are not liable for the corporation’s debts and do not have to make personal commitments to the business’s partners, unless they personally guarantee them. The business’s sector of activity may therefore favour choosing this legal form when investments are significant and financial projections are uncertain.
This legal form stands out from the others because it benefits from a lower tax rate than an individual with a high income. In addition, the business can pay out its income as salaries or dividends, or reinvest it in the business. In the latter case, the reinvested income is taxed at a lower rate and can be distributed to the appropriate persons at a later time, for example when the corporation’s income is lower.
The sale of shares of a business corporation gives the right to a capital gains exemption of $800,000 (in 2014), subject to certain conditions.
Moreover, a business corporation has better financing options. It can of course raise money by selling shares of its share capital, but it can also borrow money from financial institutions more easily than other legal forms of business.
However, a business corporation is more expensive to set up and more complex to operate. It is often necessary to work closely with professionals such as accountants and lawyers to organize the corporation and its share capital, draft shareholder agreements, keep the minute book, govern how the board of directors operates, etc.
4. Conclusion
In short, each legal form has advantages and disadvantages, depending on your business’s goals, needs and sector of activity. The wrong choice can lead to significant, even irreversible, costs and consequences.
Note: The information above is general in nature and does not constitute legal advice. For advice on your particular legal situation, feel free to contact one of our lawyers in Québec City or Lévis.
