Invest In My Idea

Running a business involves creating and managing relationships with customers, suppliers, employees, and different levels of government. Each of these relationships carries with it a separate set of responsibilities. Failing to honour these relationships can jeopardize your business and perhaps even put your personal assets at risk.

 There are different formats through which you can operate your business. Owning all of the assets and running your business yourself—referred to as a sole proprietorship— is the simplest format, requiring little in the way of professional assistance to get it up and running. Another format—the partnership—involves pooling resources with one or more people, and is more complex, requiring an agreement outlining the contribution and role of each partner in the business. Personal assets remain at risk in sole proprietorship and partnerships. The third format—incorporation—offers the best approach to protecting your assets from business loss, provided you do not personally guarantee obligations of your incorporated business.

It is not always necessary to hire a lawyer to help you with the legalities of business start-up. However, in complex situations a good lawyer can help prevent problems. If you do need a lawyer, make sure that you choose the right one for you and your business.

 New  Relationships  Mean  New  Responsibilities

Once you start a business, you lay the groundwork for a whole series of new relationships: with other owners (if there are any), customers, suppliers, employees, and the government. Each of these relationships carries its own obligations. As an owner, you can run the business as you see fit, subject to normal business and legal responsibilities.

In dealing with your customers, you have the responsibility to deliver what you promised. As a customer of suppliers, you have the responsibility of paying for goods and services that you purchase. You also have the responsibility for paying your employees for the work that they do. And, of course, you must also file various documents with all levels of government and pay any taxes that may be levied.
 
Not surprisingly, there will probably be legal consequences if you default on any of these responsibilities. If, for example, you fail to deliver to your customers what you promised, or if the goods are faulty, they can sue you for damages and any losses. Similarly, if you do not pay your suppliers or your employees they can take you to court to collect the money owning. Frequently, governments can seize assets without even having to start a court action. Subject to minor exceptions, the local sheriff can seize your assets to satisfy a judgment against you. The bottom line is that once a judgment has been awarded against you, you risk losing your assets, from bank accounts to real estate. 

 Building  Block

Your primary goal in running your own business—to generate money to earn a livelihood—also has attached to it the equally high priority of protecting your personal assets from risk of loss.

 

 Protect  Your  Personal  Assets

 Most of us would agree that it is quite reasonable for business assets to be seized to pay court judgements arising from business activities. On the other hand, it would seem quite unreasonable for personal assets that are not used for business purposes to be seized for the same purpose. The stark reality is that unless personal assets are separated from business assets, they face the same risk of seizure as business assets.

  It is important to separate personal assets from business assets. This can be achieved by transferring the registered ownership of such assets as motor vehicles, registered securities, and real estate to family members who will not also be owners of the business. Provided the transfer is completed early enough in the startup phase of the business, this time-honoured strategy can effectively protect personal or family assets. It is important that the transfer of ownership be completed with registration of appropriate documents.

The bad-news aspect of this approach is that although the assets are protected from loss through business difficulties, they are not protected from loss through family or domestic difficulties. If a business owner transfers real estate to a spouse to protect the property from business loss, the transfer cannot be reversed if the marriage subsequently breaks up.

 What’s  the  Right  Business  Format  for  You?

For tax purposes, business income is reported as income of the owner and is included on the standard personal income tax return. Similarly, business expenses and losses are deductible from that income.

 The main advantage of a sole proprietorship is its overall simplicity. It is easy to set up and maintain, and business losses can be offset against personal income.

 There are, however, some major disadvantages to this format. The owner is personally liable for all business debts and liabilities. Many owners have lost their personal assets as a result of business difficulties. As mentioned above, the only way to totally protect personal assets is to transfer ownership to a family member before starting the business.

  Also, a sole proprietorship is usually considered to be a small operation, and customers might be wary of that.
 
Frequently when sole proprietorships are sold, the seller must produce personal income tax returns as a means of confirming business income. Being as independent as they are, not many business owners would want to disclose their personal income tax return to prospective purchasers of the business.

Hot  Tip

Even if you do not anticipate earn-ing more than $30 000 in your first year of business, it is a good idea to register for GST. By collecting GST you present a professional image  to your customers. Further, if you collect GST on your sales, you are entitled to recover the GST that you pay on business purchases.

Partnership

When I was practising law, I used to believe that the worst kind of ship was a partnership. I still believe that. I continue to hear about problems associated with the breakup or dissolution of partnerships. In fact, as a lawyer, my top priority in helping clients entering partnerships was to make sure there was an equitable procedure in place when, not if, the partnership broke up.

 In a partnership, two or more owners share the profits equally, unless otherwise agreed. Each partner pays tax on his or her portion of the partnership income. Notwithstanding any partnership agreement, each partner is fully responsible for all partnership debts and liabilities. Again, unless otherwise agreed, each individual is legally authorized to act and make binding commitments on behalf of the partnership. Like sole proprietorships that operate under a name other than the owner’s, partnerships must file a form with the provincial or territorial government listing the partners’ names and addresses. This registration is usually a fairly simple process that you can handle yourself.

The major advantage of a partnership over a sole proprietorship is the pooling of resources. By combining their skills and equity, partners will have more resources to offer than they would have if they were operating as sole proprietors.

 A partnership agreement can help avoid difficulties. Below is a checklist of issues that should be addressed in such an agreement. It is usually best for the partners to reach agreement on these issues and then hire a lawyer to prepare the actual agreement. As a double-check, each partner might ask his or her lawyer to approve the agreement. But be careful to avoid involving too many lawyers in the process.

 You might find yourself triggering an expensive nitpicking contest among the lawyers. It might be possible to avoid this contest by placing a limit on the amount you are prepared to pay your lawyer for reviewing the agreement. 

Issues  to  Be  Addressed  in  a  Partnership  Agreement

Who are the partners?  Note that a corporation can be a partner.
 
Firm name. This is the name under which the business is carried. To avoid thepossibility of conflict with a similar business using the same or a comparable name, conduct a name search at the same government agency that registers names.
 
Term of partnership. This refers to the date on which the partnership started.Unless otherwise agreed, the partnership starts when the agreement is signed.
 
Place of business.  Where is the partnership going to carry on business?
 
Description of business. What will the business do? What limitations are there on partners’ activities outside of the partnership, both when active as a partner and after retirement?
 
Amount of contribution to capital. How much does each partner contribute to the capital of the business? What happens if the business requires more capital? Unless otherwise agreed, partners contribute and share equally.
 
Records. What accounting and other records will be maintained? What statementswill be given to partners? When? Unless otherwise agreed, all partners have equal access to partnership books.
 
Fiscal year.  When will the fiscal year begin and end?
 
Accounting principles. Will assets be valued at cost, market, or depreciatedvalue? How will goodwill be valued? What policies will determine depreciation, interest on partners’ advances and capital, write-offs, reserves, and payment of partners’ personal expenses? How will profits be calculated?
 
Banking arrangements. What bank will the business use? What kinds ofaccounts will be used, and who will have signing authority?
 
Restriction on partners’ interests. Can partners pledge their partnership interests as security for loans? If so, what protection can be given to the other part-ners? Can interests be sold to outsiders? It is usually better to prohibit pledging or selling partnership interests.
 
Time commitments. Will all partners devote full time and attention to the partner-ship? If not, how will compensation be adjusted to reflect part-time involvement?
 
Management. Who is in charge of sales, management, administration, and so on? What can and cannot be done without the approval of other partners? If approval is necessary, how is this approval to be obtained? Who signs contracts on behalf of the partnership?
 
Partnership draws. How often and how much can partners draw against profits? If partners draw too much, the business may have to borrow funds to maintain its cash flow.
 
Expulsion, retirement, bankruptcy, or death of partner. How will these events be handled to ensure that the business will continue and that the departing partner (or estate) receives payment for partnership interest? Should there be a pro-vision prohibiting departing partners from competing with the business? How will the interest of a departing partner be valued? Must remaining partners purchase this interest? If so, what are the criteria for doing so?
 
Dissolution of partnership. What actions will, and will not, automatically dissolve a partnership? What procedure will be followed on dissolution?

Partnership property.  How will ownership of partnership property be registered?
 
Insurance. What kinds of insurance coverage will the partnership carry? Will partners be required to insure each other’s lives to fund the purchase of the interest of a deceased partner?
 
Arbitration of disputes. If a dispute arises, how will it be arbitrated without hav-ing to go to court?
 
Amending agreement.  When and how can the agreement be amended?
 
Depending on the nature of the partnership, not all of these provisions may apply. As stated above, before signing a partnership agreement, especially if the terms are fairly complex, it is best to have the agreement reviewed by each partner’s lawyer.
 
Partnerships share the same disadvantages as sole proprietorships, as outlined above.

Incorporation

A corporation, or limited company, is a distinct legal entity whose rights and obligations are separate from those of its owners. It can run a business in the normal manner: borrowing money, buying and selling goods and services, hiring and paying employees, and so on. The magic feature of a corporation is the fact that its owners (shareholders) are not automatically liable for its debts; nor is the corporation automatically liable for the debts of its shareholders. As a result, personal assets are not at risk of being seized to pay the debts of an incorporated business.

As if that is not a good enough reason to incorporate a company to run a business, there are potential tax savings associated with incorporated businesses. These savings include lower small-business corporate tax rates, certain capital gains exemptions, and increased flexibility in income splitting and estate planning.
 
With these major benefits, I am at a loss to understand why all owners of businesses do not incorporate. The main argument that I have heard against incorporation is the added cost.

 Granted there are out-of-pocket expenses of $300 to $500 for filing the articles of incorporation, and yes, these one-time fees are higher than  the filing fee of less than $100 that is normally paid to file declarations of partnerships. But because the vast majority of incorporated businesses are fairly simple and straightforward, most owners can prepare and file the necessary documents themselves. Hard copy and electronic incorporation guides are available in major book and office supply stores, in most public libraries, and on the Internet. Paralegals, also called legal clerks, can also help with the preparation and filing of forms. Thus, the main expense of incorporation, lawyers’ fees, can often be reduced.
 
With the high cost of legal fees eliminated from the equation, the only other argument against incorporating a business is the increased complexity and operating cost. Although there certainly are additional forms, filings, and costs for incorporated companies, these additional costs are insignificant when compared to the protection offered.