Determining the Appropriate Legal Entity for a Transaction
Before proceeding too far into the business transaction, we prefer to meet with our client to discuss the options available when purchasing a business. Some clients are comfortable proceeding as a sole proprietorship which is the most simple form of business entity. The business is owned by the individual, who is the sole owner and who claims the income or losses on his or her personal tax return. While this may work for some clients, often there are reasons why a more complex form of business ownership is appropriate.
If more than one person is involved, a partnership could be considered. If a partnership is the preferred option, we normally recommend that the clients take the time prior to the purchase to form an official partnership agreement that sets out how the business will be operated between the partners. An official partnership agreement is not required though, so while it may be a more complex arrangement, clients can move forward without much more expense. A partnership will be subject to different laws and tax arrangements, so we normally do like to discuss this option with the clients and their other professional advisors.
Another option is to form a BC company to act as the business owner. Companies are separate legal entities from their shareholders (owners) and while a company is more complex than a sole proprietorship and (sometimes) more complex than a partnership, they are often used by clients when buying a business. The benefits of incorporation include limited liability for shareholders, that ownership can be shared among many individuals with different rights/responsibilities among them, and that spouses and other family members can be included as shareholders for tax planning purposes. The drawbacks to incorporation include an increased initial outlay for creating the company for professional fees, some additional expenses annually for additional corporate and tax filings, and an additional level of complexity in which the clients must learn to operate.
The additional expenses may be nominal when compared to the security that limited liability provides to the individual shareholders, or when compared to the tax advantages gained through incorporation. In a partnership or a sole proprietorship the individuals will be personally liable if sued or if losses are incurred. In a company, unless the shareholders sign personal guarantees or are found to be negligent, the company remains liable for company losses, which amounts are not transferred to the shareholders. So, if the company is at risk, the houses, bank accounts and other assets of the shareholders are not at risk. For some clients, this is of key importance while for others, this may not matter. It could depend on the amount of income generated and the amount of risk associated with the business.