What is the major advantage of forming a corporation rather than operating as a sole proprietorship?

By the end of this chapter, you should be able to:

• Identify the questions to ask in choosing the appropriate form of ownership for a business.
• Describe the sole proprietorship and partnership forms of organization, and specify the advantages and disadvantages.
• Identify the different types of partnerships, and explain the importance of a partnership agreement.
• Explain how corporations are formed and how they operate.
• Discuss the advantages and disadvantages of the corporate form of ownership.
• Examine special types of business ownership, including limited liability companies, cooperatives, and not-for-profit corporations.
• Define mergers and acquisitions, and explain why companies are motivated to merge or acquire other companies.

The Family Golf Business!

Who would have thought it? Spouses that ran a successful fuel company for the better part of twenty years, decided to cash it in and take a gamble on the golf business.  In 1996, Bob and Debbie Foster of Burford Ontario took a leap of faith and purchased Burford Golf Links,  a challenging 18 Hole – Par 71 golf course outside the village of Burford. With close proximity to Brantford, Woodstock and Paris, the Fosters realized the potential of the golf course and the required amenities to attract loyal customers.

With no formal golf course training, the family relied on years of business experience and entrepreneurial spirit to make the operation successful. Though the learning curve was steep, the family poured countless hours into gaining an understanding of the stakeholders, procedures, processes and the importance of key staff with specific expertise. Burford Golf Links was operated as a Limited Company with two shareholders (Bob & Debbie).

A limited company (LC) is a general term for a type of business organization wherein owners’ assets and income are separate and distinct from the company’s assets and income; known as limited liability.   Though there are extra expenses in setting up your business as an LC, limited companies come with a number of benefits. They include:

• A limited company and the people who run it are legally distinct.
• A limited company structure provides a firewall between the finances of the company and its owners.
• A limited company is allowed to own assets and retain any profits made after-tax.
• A limited company can enter into contracts on its own. [1]

The Canadian Landscape

Innovation, Science and Economic Development Canada (ISED) defines a business based on the number of paid employees. For this reason, self-employed and “indeterminate” businesses are generally not included in the present publication as they do not have paid employees. Accordingly, this publication defines an SME (small-to-medium enterprise) as a business establishment with 1–499 paid employees, more specifically:

• A small business has 1 to 99 paid employees.
• A medium-sized business has 100 to 499 paid employees.
• A large business has 500 or more paid employees 

“As of December 2019, there were 1.17 million employer businesses in Canada, Small Business Statistics Of these, 1.20 million (97.9 percent) businesses were small businesses, 22,905 (1.9 percent) were medium-sized businesses and 2,978 (0.3 percent) were large enterprises.” [2]

Business Ownership – Factors to Consider 

If you’re starting a new business, you have to decide which legal form of ownership is best for you and your business. Do you want to own the business yourself and operate as a sole proprietorship? Or, do you want to share ownership, operating as a partnership or a corporation? Before we discuss the pros and cons of these three types of ownership, let’s address some of the questions that you’d probably ask yourself in choosing the appropriate legal form for your business.

1. In setting up your business, do you want to minimize the costs of getting started? Do you hope to avoid complex government regulations and reporting requirements?
2. How much control would you like? How much responsibility for running the business are you willing to share? What about sharing the profits?
3. Do you want to avoid special taxes?
4. Do you have all the skills needed to run the business?
5. Are you likely to get along with your co-owners over an extended period of time?
6. Is it important to you that the business survive you?
7. What are your financing needs and how do you plan to finance your company?
8. How much personal exposure to liability are you willing to accept? Do you feel uneasy about accepting personal liability for the actions of fellow owners?

No single form of ownership will give you everything you desire. You’ll have to make some trade-offs. Because each option has both advantages and disadvantages, your job is to decide which one offers the features that are most important to you. In the following sections, we’ll compare three ownership options (sole proprietorship, partnership, corporation) on these eight dimensions.

Forms of Business Ownership

Watch the video: Forms of Business Ownership by Jessica Blaisdell [5:02] (transcript available) to learn more about the different forms of business ownership.

Sole Proprietorship

In a sole proprietorship, you make all important decisions and are generally responsible for all day-to-day activities. In exchange for assuming all this responsibility, you get all the income earned by the business. Profits earned are taxed as personal income, so you don’t have to pay any special federal and provincial income taxes.

Disadvantages of Sole Proprietorships

For many people, however, the sole proprietorship is not suitable. The flip side of enjoying complete control is having to supply all the different talents that may be necessary to make the business a success. And when you’re gone, the business dissolves. You also have to rely on your own resources for financing: in effect, you are the business and any money borrowed by the business is loaned to you personally. Even more important, the sole proprietor bears unlimited liability for any losses incurred by the business. The principle of unlimited personal liability means that if the business incurs a debt or suffers a catastrophe (say, getting sued for causing an injury to someone), the owner is personally liable. As a sole proprietor, you put your personal assets (your bank account, your car, maybe even your home) at risk for the sake of your business. You can lessen your risk with insurance, yet your liability exposure can still be substantial. Given that Ben and Jerry decided to start their ice cream business together (and therefore the business was not owned by only one person), they could not set their company up as a sole proprietorship.

Partnership

A partnership (or general partnership) is a business owned jointly by two or more people. About 10 percent of U.S. businesses are partnerships [3] and though the vast majority are small, some are quite large. For example, the big four public accounting firms, Deloitte, PwC, Ernst & Young, and KPMG, are partnerships. Setting up a partnership is more complex than setting up a sole proprietorship, but it’s still relatively easy and inexpensive. The cost varies according to size and complexity. It’s possible to form a simple partnership without the help of a lawyer or an accountant, though it’s usually a good idea to get professional advice. Professionals can help you identify and resolve issues that may later create disputes among partners.

Provincial and federal governments also support small businesses and offer free resources as well as opportunities for funding.

• Canada Business Network (@canadabusiness #SMEPME) is a collaborative arrangement among federal departments and agencies, provincial and territorial governments, and not-for-profit entities. It offers webinars and other learning events across the country.
• Ontario’s Small Business Access, offers workshops, a helpline, funding, and provides up-to-date information on legal requirements.

The Partnership Agreement

The impact of disputes can be lessened if the partners have executed a well-planned partnership agreement that specifies everyone’s rights and responsibilities. The agreement might provide such details as the following:

• Amount of cash and other contributions to be made by each partner
• Division of partnership income (or loss)
• Partner responsibilities—who does what
• Conditions under which a partner can sell an interest in the company
• Conditions for dissolving the partnership
• Conditions for settling disputes

Unlimited Liability and the Partnership

A major problem with partnerships, as with sole proprietorships, is unlimited liability: in this case, each partner is personally liable not only for his or her own actions but also for the actions of all the partners. If your partner in an architectural firm makes a mistake that causes a structure to collapse, the loss your business incurs impacts you just as much as it would him or her. And here’s the really bad news: if the business doesn’t have the cash or other assets to cover losses, you can be personally sued for the amount owed. In other words, the party who suffered a loss because of the error can sue you for your personal assets. Many people are understandably reluctant to enter into partnerships because of unlimited liability. Certain forms of businesses allow owners to limit their liability. These include limited partnerships and corporations.

Limited Partnerships

The law permits business owners to form a limited partnership which has two types of partners: a single general partner who runs the business and is responsible for its liabilities, and any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.

Advantages and Disadvantages of Partnerships

The partnership has several advantages over the sole proprietorship. First, it brings together a diverse group of talented individuals who share responsibility for running the business. Second, it makes financing easier: the business can draw on the financial resources of a number of individuals. The partners not only contribute funds to the business but can also use personal resources to secure bank loans. Finally, continuity needn’t be an issue because partners can agree legally to allow the partnership to survive if one or more partners die.

Still, there are some negatives. First, as discussed earlier, partners are subject to unlimited liability. Second, being a partner means that you have to share decision-making, and many people aren’t comfortable with that situation. Not surprisingly, partners often have differences of opinion on how to run a business, and disagreements can escalate to the point of jeopardizing the continuance of the business. Third, in addition to sharing ideas, partners also share profits. This arrangement can work as long as all partners feel that they’re being rewarded according to their efforts and accomplishments, but that isn’t always the case. 

Corporation

A corporation (sometimes called a regular or C-corporation) differs from a sole proprietorship and a partnership because it’s a legal entity that is entirely separate from the parties who own it. It can enter into binding contracts, buy and sell property, sue and be sued, be held responsible for its actions, and be taxed. Once businesses reach any substantial size, it is advantageous to organize as a corporation so that its owners can limit their liability. Corporations, then, tend to be far larger, on average, than businesses using other forms of ownership. Most large well-known businesses are corporations, but so are many of the smaller firms with which likely you do business.

Ownership and Stock

Corporations are owned by shareholders who invest money in the business by buying shares of stock. The portion of the corporation they own depends on the percentage of stock they hold. For example, if a corporation has issued 100 shares of stock, and you own 30 shares, you own 30 percent of the company. The shareholders elect a board of directors, a group of people (primarily from outside the corporation) who are legally responsible for governing the corporation. The board oversees the major policies and decisions made by the corporation, sets goals and holds management accountable for achieving them, and hires and evaluates the top executive, generally called the CEO (chief executive officer). The board also approves the distribution of income to shareholders in the form of cash payments called dividends. 

An example of this is ClubLink which is traded publicly on the Toronto stock exchange (TSE) under TWC Enterprises Limited [TWC:CA] TWC is engaged in club operations under “ClubLink” which is Canada’s largest owner and operator of golf clubs across Ontario, Quebec and Florida.

Benefits of Incorporation

The corporate form of organization offers several advantages, including limited liability for shareholders, greater access to financial resources, specialized management, and continuity.

Drawbacks to Incorporation

Like sole proprietorships and partnerships, corporations have both positive and negative aspects. In sole proprietorships and partnerships, for instance, the individuals who own and manage a business are the same people. Corporate managers, however, don’t necessarily own stock, and shareholders don’t necessarily work for the company. This situation can be troublesome if the goals of the two groups differ significantly.

Managers, for example, are often more interested in career advancement than the overall profitability of the company. Stockholders might care more about profits without regard for the well-being of employees. This situation is known as the agency problem, a conflict of interest inherent in a relationship in which one party is supposed to act in the best interest of the other. It is often quite difficult to prevent self-interest from entering into these situations.

Another drawback to incorporation—one that often discourages small businesses from incorporating—is the fact that corporations are more costly to set up. When you combine filing and licensing fees with accounting and attorney fees, incorporating a business could set you back by $1,000 to $6,000 or more depending on the size and scope of your business. [4] Additionally, corporations are subject to levels of regulation and government oversight that can place a burden on small businesses. Finally, corporations are subject to what’s generally called “double taxation.” Corporations are taxed by the federal and provincial governments on their earnings. When these earnings are distributed as dividends, then shareholders pay taxes on these dividends. Corporate profits are thus taxed twice—the corporation pays the taxes the first time and the shareholders pay the taxes the second time.

Read: Incorporation: Tax savings, but more paperwork a 2017 article in The Globe and Mail that puts incorporation into the Canadian perspective.

Other Types of Business Ownership

In addition to the three commonly adopted forms of business organization—sole proprietorship, partnership, and regular corporations—some business owners select other forms of organization to meet their particular needs. We’ll look at several of these options:

• Limited liability companies
• Cooperatives
• Not-for-profit corporations

Limited Liability Companies

How would you like a legal form of organization that provides the attractive features of the three common forms of organization (corporation, sole proprietorship, and partnership) and avoids the unattractive features of these three organization forms? The limited liability company (LLC) accomplishes exactly that. This form provides business owners with limited liability (a key advantage of corporations) and no “double taxation” (a key advantage of sole proprietorships and partnerships). We now need to point out some circumstances under which an LLC member (or a shareholder in a corporation) might be held personally liable for the debts of his or her company. A business owner can be held personally liable if he or she:

• Personally guarantees a business debt or bank loan which the company fails to pay.
• Fails to pay employment taxes to the government.
• Engages in fraudulent or illegal behavior that harms the company or someone else.
• Does not treat the company as a separate legal entity, for example, use company assets for personal uses.

Cooperatives

A cooperative (also known as a co-op) is a business owned and controlled by those who use its services. Individuals and firms who belong to the cooperative join together to market products, purchase supplies, and provide services for its members. If run correctly, cooperatives increase profits for its producer-members and lower costs for its consumer-members. Cooperatives are fairly common in the agricultural community, however, there are some good examples that have an impact on the hospitality industry and namely golf facilities.

The London Brewing Co-op is a micro-brewery located in the city of London, Ontario.  The business supplies many businesses including golf courses.  Its mission statement is “We believe that great beers start with superior ingredients. That’s why we choose the finest local and organic malts and hops available. However, contained within the pint is far more than just a great beer. It’s a beer that celebrates the hard work and wisdom of local farmers. It’s a beer that values relationships, cooperation, and community. It’s a beer that recognizes the finite nature of our home planet, and the need to make sustainable choices in everything we do. It’s a beer that believes that a more equitable society starts with a democratic workplace. In short, contained within is a great beer that can better our world, one pint at a time.”[5]

Not-for-Profit Corporations

A not-for-profit corporation (sometimes called a nonprofit) is an organization formed to serve some public purpose rather than for financial gain. As long as the organization’s activity is for charitable, religious, educational, scientific, or literary purposes, it can be exempt from paying income taxes. Additionally, individuals and other organizations that contribute to the not-for-profit corporation can take a tax deduction for those contributions. The types of groups that normally apply for nonprofit status vary widely and include churches, synagogues, mosques, and other places of worship; museums; universities; and conservation groups.

Since Statistics Canada ended its deep collection of nonprofit statistics in 2008;

• 170,000 charitable and non-profit organizations in Canada
• 85,000 of these are registered charities (recognized by the Canada Revenue Agency).
• The charitable and nonprofit sector contributes an average of 8.1% of total Canadian GDP, more than the retail trade industry and close to the value of the mining, oil, and gas extraction industry 
• Two million Canadians are employed in the charitable and nonprofit sector 
• Over 13 million people volunteer for charities and nonprofits

In a 2020 report, non-profit organizations represented 8.9% of gross domestic product (GDP) in Canada. Specifically, non-profit organizations serving households or individuals and businesses made up 2.2% of GDP and employed approximately 788,000 people, representing 4.5% of all jobs in Canada. [6]

Golf Industry Non-Profits

“Non-Profits exist in the golf industry. The London Hunt and Country Club files as a not-for-profit under the Ontario Corporations Act. The ONCA (Ontario Not-for-Profit Corporations Act) will come into effect soon which will change some of our corporate structure, but as of now we file as a not-for-profit. We are a share capital corporation presently, which is one of the things that will change in the future. In other words, shareholders have a say in the direction of the club. However, these shares only have voting rights, and do not pay dividends and are non-transferrable. If a member leaves the Club, the share is voided. Face value of shares is $10. As a not for profit, we use the word “contribution” instead of profit, and we usually don’t budget to make a profit. However, contributions can be earmarked for future use, which usually happens as capital improvements.” [7]

Golf Town Sporting Life Merger

Retailers Golf Town and Sporting Life merged in 2018 to form a new company called Sporting Life Group. The merger plan was for both companies to retain their brand and organizational structure while taking advantage of the opportunities of the alliance. According to company president Chad McKinnon:

“The goal of this merger is to strategically position Sporting Life Group as a pre-eminent sports lifestyle retailer in Canada and create a more complete operation with exceptional processes, a premium experience for our customers, and stronger relationships with our partners. The end game for this merger is readily apparent. Applied synergies between the two sporting brands under the umbrella of a single company will assist in a number of critical business areas, including sustainability, profitability, and growth potential while aligning to be an asset in future expansion opportunities for both brands either in Ontario, across Canada or beyond.” [8]

Though they are often used as if they’re synonymous, the terms merger and acquisition mean slightly different things. A merger occurs when two companies combine to form a new company. An acquisition is the purchase of one company by another.

An example of an acquisition is the purchase of Reebok by Adidas for $3.8 billion. [9] The deal was expected to give Adidas a stronger presence in North America and help the company compete with rival Nike. Once this acquisition was completed, Reebok as a company ceased to exist, though Adidas still sells shoes under the Reebok brand.

Motives Behind Mergers and Acquisitions

Companies are motivated to merge or acquire other companies for a number of reasons, including the following.

• Gain Complementary Products or Services
• Attain New Markets or Distribution Channels
• Realize Synergies

Key Terms

SME (small-to-medium enterprise) is a business establishment with 1–499 paid employees.

Sole proprietorship is an individual who may or may not employ other people but owns and operates the business.

Partnership is a business owned jointly by two or more people. Partnership have unlimited liability where each partner is liable for the debts of the other partners, including their tax liability.

Limited partnership (LP) exists when two or more partners go into business together, but the limited partners are only liable up to the amount of their investment. A limited partnership has limited partners and a general partner with unlimited liability.

Corporation is a legal entity that is entirely separate from the parties who own it. Once businesses reach a substantial size, it is advantageous to organize as a corporation so that its owners can limit their liability.

Limited liability company is where the owners or shareholders are financially only responsible for the amount they have invested in the company rather than their personal wealth. The importance of limiting the amount of a shareholder’s liability is that it encourages people to invest with relatively little risk.

Cooperative is a business owned and controlled by those who use its services – producers, customers, or consumers.

A not-for-profit corporation (sometimes called a nonprofit) is an organization formed to serve some public purpose rather than for financial gain.

Merger is a term used to describe an agreement between the management and shareholders of two companies of approximately equal size to bring both companies together under a common board of directors.

Acquisition is a term used when one company purchases another company.

1. A sole proprietorship is a business owned by only one person.
   • Advantages include: complete control for the owner, easy and inexpensive to form, and the owner gets to keep all of the profits.
   • Disadvantages include: unlimited liability for the owner, complete responsibility for talent and financing, and business dissolve if the owner dies.
2. A general partnership is a business owned jointly by two or more people.
   • Advantages include: more resources and talents come with an increase in partners, and the business can continue even after the death of a partner.
   • Disadvantages include: partnership disputes, unlimited liability, and shared profits.
3. A limited partnership has a single general partner who runs the business and is responsible for its liabilities, plus any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.
4. A corporation is a legal entity that’s separate from the parties who own it, the shareholders who invest by buying shares of stock. Corporations are governed by a Board of Directors, elected by the shareholders.
   • Advantages include: limited liability, easier access to financing, and unlimited life for the corporation.
   • Disadvantages include: the agency problem, double taxation, and incorporation expenses and regulations.
5. A limited liability company (LLC) is similar to a C-corporation, but it has fewer rules and restrictions than a C-corporation. For example, an LLC can have any number of members.
6. A cooperative is a business owned and controlled by those who use its services. Individuals and firms who belong to the cooperative join together to market products, purchase supplies, and provide services for its members.
7. A not-for-profit corporation is an organization formed to serve some public purpose rather than for financial gain. It enjoys favorable tax treatment.
8. A merger occurs when two companies combine to form a new company.
9. An acquisition is the purchase of one company by another with no new company being formed.