An Overview of Available Business Structures
 

The New Generation Cooperative (NGC) is a relatively new concept on the Canadian prairies.  Recently, lawmakers have been struggling with how to fit the NGC form of business into cooperative legislation.  An NGC represents a group of agricultural producers who share an interest in owning a business that extends their activities past the farm gate.  The objective of an NGC is to move farmers up the value chain.  However, there are several other types of business structure that could be used for value-added businesses.  The choice of structure to use depends on the particular circumstances of the business.  This section will provide a brief description of the various business structures available.  The purpose of this chapter is not to provide all of the relevant legal and financial information that is needed to decide on a business structure.  Rather, this section provides a brief overview that can help prepare the reader for discussions with lawyers, accountants, and other advisors when making the final decision as to which type of structure to use to organize a business. 

There are four common forms of business ownership in Canada:


In order to understand the New Generation Cooperative business structure, it is useful to compare these four forms of business organization.  These forms of business structure are outlined below.

Cooperatives

A cooperative is a type of corporation and is governed by similar laws.  For the purposes of this booklet, corporations other than cooperatives are referred to as investor-owned corporations.  A cooperative is generally described as a business that is organized, owned and democratically controlled by the people who use its products and services, and whose earnings are distributed on the basis of use of the cooperative rather than level of investment.  A distinct feature of a cooperative organization is that the role of owner and patron or user are closely connected.  A patron or user refers to a person who conducts business with the cooperative.  A cooperative is distinct because there is a linkage between the ownership and the users of the business.  A member is an individual who owns the cooperative and who is also a user of the cooperative in some way.  In contrast, a shareholder of an investor-owned corporation owns the business because he owns shares in the business, but the shareholder might never be a user of the corporation’s business.  For example, a person might own shares in a meat processing company but might never purchase a meat product from that company or supply raw materials to the company. 

Cooperatives, like investor-owned corporations, have elected boards of directors and appointed officers.

Members control the cooperative through the election of directors.  The members exert their control through voting power that is attached to their membership.  Unlike investor-owned corporations, in which voting power is proportional to the number of shares held, voting power in a cooperative is based on the principle of one member, one vote.  Each member has only one vote in the affairs of the cooperative, regardless of the level of equity that he has invested.

 Traditionally, a person can qualify for membership in a cooperative by purchasing one or more shares with a fixed (and often nominal) value.  On termination of membership, the cooperative will repurchase the share (on a priority) basis at the original purchase price.

Recent legislation in Manitoba created new opportunities for structuring and financing cooperatives.  Our newly updated Cooperatives Act allows cooperatives to offer shares that can attract outside investment or increased member investment.  These new “investment shares” can be used to reward non-members in a variety of ways for providing risk capital to the cooperative.  Non-member investors may be given voting power in limited circumstances, including the right to elect representatives to the cooperative’s board of directors.  “Special investment shares” can be issued by an NGC, which shares may reflect the market or perceived value of the rights which ownership of the shares creates, rather than a permanently fixed value.

Advantages of a cooperative
 

  • Cooperatives have many of the same advantages of investor-owned corporations such as limited liability of owners and perpetual existence of the cooperative.
  • Whereas investor-owned corporations are typically exposed to double taxation because dividends to shareholders are distributed out of after-tax corporate income, cooperatives are allowed to deduct patronage refunds to members out of before-tax income.  Thus, income may only be taxed at the individual member level rather than at both the cooperative and member level.  In other words, a cooperative does not pay tax on income that it distributes as patronage dividends.
  • Cooperatives are organized on a democratic principle of one member, one vote.
  • Control of the business is kept in the hands of those who use the business.
  • No one investor, or group of investors, can dominate the decision-making simply because they have made a large investment in the business.  This is particularly attractive to members who are smaller than other members of the cooperative.
  • However, this may serve as a disadvantage, as it will deter investors who desire control proportional to their investment.
Disadvantages of a cooperative
 
  • Traditionally, equity financing was only available from cooperative members, with most new members only required to contribute nominal capital.  However, the flexibility of issuing investment shares to non-members may provide some cooperatives with greater access to capital.  Cooperatives issuing shares to the general public will have to obtain clearance from the Securities Commission, which could become a long and costly process.  Special investment shares (delivery rights) issued by an NGC may be subject to less scrutiny by the regulators, but the issue of such shares will always require a filing or a disclosure document if an exemption from an offering statement is granted by the Registrar.  
  • Cooperatives may not provide incentives for members to contribute additional capital.
  • Since the benefits from being a member of a cooperative arise through the level of use of the cooperative rather than the level of equity invested, members do not have an incentive to invest in equity capital of the cooperative.
  • Some entrepreneurs will not be motivated to invest in the cooperative because they are not satisfied with democratic voting arrangements and dividends that are based purely on patronage.
  • Cooperatives need to consider an equity redemption plan.
  • In order to finance business growth, cooperatives maintain some patronage earnings in the cooperative rather than distribute them as cash dividends to members.  Cooperatives must decide how much patronage-based earnings to retain in the business (by increasing members’ equity positions in the cooperative) and how much to immediately pay out in the form of cash patronage payments. Because retained patronage earnings must eventually be returned to members, cooperatives should have a well-designed equity redemption program in place.

 
 

The cooperative is a business structure that should be considered, together with corporations, partnerships, and other alternatives in any situation where primary producers are considering pooling their resources to carry on business together.

Individuals considering a cooperative as an option should seek tax and legal advice to ensure that the long-term interests and needs of each of the cooperative’s members and investors are properly advanced and protected.  In doing so, it must be remembered that each party may have different requirements and expectations of the benefits that the cooperative will provide.
 

Corporations

A corporation is distinct from a sole proprietorship and partnership in one fundamental way: it is a separate legal entity.  It has a legal existence independent from the owners of the business.  It can buy, own, and sell property, sue and be sued, and must file its own income tax return.

There are three main groups of people involved in a corporation:

  • Shareholders 
    • They are the owners of the corporation.  Common shareholders are entitled to vote at shareholders’ meetings on company-related issues such as electing the board of directors and choosing an auditor.  Most shareholders are not involved in managing the affairs of the corporation.
    • Shareholders’ liability for debts of the corporation is limited to the price they paid for the shares they own.
    • Shareholders receive a portion of profits based on the type and number of shares they own in the corporation.
    • They are entitled to share the assets if the corporation dissolves, after all debt obligations have been satisfied.
  • Board of Directors
    • The board of directors is elected by the shareholders to guide the affairs of the corporation.
    • Directors owe a fiduciary duty to the corporation, and must disclose any personal interest in any business in which the corporation participates.
  • Officers
    • Officers are hired by the board of directors.  They are responsible for the day-to-day management of the corporation
    • Unlike shareholders, officers can legally bind the corporation to contracts they sign on its behalf.


In contrast to sole proprietorships or partnerships, a corporation is subject to double taxation.  Because it is a separate legal entity, any profits of a corporation are taxed according to corporate income tax rates.  Then, if after-tax profits are distributed to shareholders in the form of dividends, the shareholders will be taxed on these dividends.  Thus, income from a corporation can be taxed twice: once at the corporate level, and then again when the income is distributed to shareholders in the form of dividends.  Shareholder income from dividends does, however, get some form of tax relief in the form of dividend tax credits.

Advantages of a corporation
 

  • A corporation provides limited liability for the owners (shareholders); shareholders are only liable to the extent of their investment in the shares of the corporation.
  • As a separate legal entity, the corporation is responsible for its own debts and obligations.
  • A corporate structure provides flexibility in the organization of the business, and in the relationship between the owners.
  • A corporation has a perpetual existence, so it does not end upon the death of one of the shareholders.
  • This perpetual existence allows for simpler estate planning, without the necessity of re-negotiation of partnership agreements each time a change is made.
  • Control and ownership of a corporation are easily transferable by selling shares.
  • Corporations may facilitate access to capital because additional shares in the corporation can be sold to raise funds.
  • A corporation may be the preferable structure when there is a large number of owners, as it provides for a formal decision-making hierarchy.
  • A shareholder can contract with or sue the corporation, whereas a partner can do neither with respect to the partnership and must contract with or sue the partners individually.
  • A corporation can provide flexibility of financing.
  • The corporation can create different classes of shares, with varying rights and characteristics.
  • This flexibility provides more options to investors, as they can obtain a type of investment that most properly fits with their own investment objectives.
  • Some government assistance is only available to corporations.
  • Corporations may offer possible tax advantages compared to other forms of organization.  For example, small businesses that have incorporated may be eligible for the small business deduction.
Disadvantages of a corporation
 
  • The costs of creating and maintaining the corporation can be very high.  For instance, the required legal and accounting work may be significant.
  • Laws governing corporations are more complex.  If a corporation’s shares are publicly traded, then the corporation must also follow stringent financial reporting and securities commission requirements.
  • Shareholders cannot use corporate losses to offset their personal income.


Sole Proprietorships

A sole proprietorship is the simplest and most common form of business structure, and it is the oldest form of legal ownership in Canada.  It is owned by one person who retains all of the legal rights and bears all of the responsibilities associated with the business.  The owner enjoys all of the profits flowing from the business and is responsible for all of its debts.  The business is not considered as a separate entity from the owner.  In other words, the firm is part of the owner.  The income of the business is reported as personal income on the owner’s personal income tax return, and is taxed at the same rate as the owner’s other personal income, if any.

Advantages of a sole proprietorship
 

  • A sole proprietorship is the simplest and least expensive type of organization to create or dissolve.
  • Sole proprietorships are not governed by any specific legislation.  Each province, however, has some specific regulations.
  • The owner retains absolute control over business decisions and is the sole owner of any profits from the business.
  • The profits of the business are not taxed as a separate entity, only as part of the owner’s personal income.
  • Unlike an employee, a sole proprietor can deduct business expenses from personal income.
  • The owner may derive personal satisfaction from being one’s own boss.
Disadvantages of a sole proprietorship
 
  • The owner faces unlimited liability.  Unlike some other business structures, a sole proprietorship is not a separate entity from the owner.  Unlimited liability occurs because there is no legal distinction between the owner and the business. 
  • With regard to liability and taxation, the owner and the business are one in the same.
  • Therefore, the owner can be held personally liable for all business debts, or for negligent acts of employees in the course of business.
  • Creditors can seize the personal assets of the owner for non-payment of business debts.  Unlimited liability implies that the owner is liable for claims against the business, even those that go beyond the value of his or her ownership in the firm.
  • The ability to obtain financing may be impaired because the amount of money the owner is able to invest in the business is limited to what available resources he or she has and what he or she is able to borrow.
  • In contrast to some other business structures, in which funds can be raised through the sale of equity in the business, the only option available to sole proprietorships is debt financing.
  • The ability to obtain this debt financing will depend greatly on the value of the owner’s personal assets that can be used for collateral.
  • The owner is solely responsible for all aspects of the business, from day-to-day operation to securing financing.  If the business grows, the managerial responsibilities may become too large for one person to handle.
  • Upon death of the owner, the business is legally terminated.
  • The assets may be transferred to a new owner who establishes a new sole proprietorship, but the new owner acquires the business free and clear of all debts, obligations, and other liabilities of the original owner.
  • As a consequence, the resulting taxes payable by the owner’s estate may be so substantial that some assets must be sold to meet these obligations.

 

Partnerships

A partnership is established when two or more people agree to pool their financial, managerial, and technical resources in order to operate a business for profit.  Partnerships are most commonly found in professions such as law and accounting.  The definition of a partnership, as enumerated in the provincial Partnership Act, is the relation which subsists between persons:

  • carrying on a business in common,
  • with a view to profit from the business.


Each partner owes every other partner a duty to act in the best interests of the partnership.  Like a sole proprietorship, a partnership is not taxed as a business that is separate from its owners.  The income from the partnership is included as part of the partners’ personal incomes and taxed accordingly.

Creation of a Partnership

Partnerships may be created either by agreement between the parties, or by the conduct of the parties.  However, where a partnership is the desired form of business structure, it is recommended that the partners draw up a written Partnership Agreement.  This can help greatly in the settlement of any disputes that may arise in connection with the business of the partnership.

Advantages of a partnership
 

  • Because two or more people will be in business together, they can combine their finances in order to invest more than either could have done individually.
  • A partnership will most likely be able to borrow more than a sole proprietorship because creditors will have the collateral of two or more people instead of only one to secure their lending.
  • Partners can pool their talents so that each person can focus on his or her area of expertise in the business.


Disadvantages of a partnership
 

  • Like a sole proprietorship, partners in a partnership are also exposed to unlimited liability incurred by the business.
    • However, unlike a sole proprietorship, each partner can legally bind every other partner.
    • Each partner is jointly and severally liable for all partnership debts, so a partner can be held personally liable for any debts, obligations or wrongful acts of another partner.
  • The partnership ends every time a partner leaves, unless provided for in a partnership agreement.  In addition, a partner cannot simply withdraw his or her investment from the business.  He or she must find someone (or another current partner) who is willing to buy into the partnership in order to replace the exiting partner, and this candidate must be acceptable to the remaining partners.
  • Management decisions may be more complex and more difficult to make, particularly when disagreements among partners occur.
    • A properly drawn partnership agreement may provide for a mechanism to resolve any decision-making problems.
  • Start-up costs can be as high as, or even higher than, the cost of incorporating, once a properly drawn partnership agreement is taken into account.


Limited Partnerships

Limited Partnerships are a special form of partnership, often used where investors want the tax treatment that comes from a partnership relationship, without incurring personal liability for all of the partnership debts.  When a limited partnership is formed, one of the partners (usually a corporation with no assets, formed and controlled by the promoter of the investment for this sole purpose) is designated as the "general partner" and all other investors are usually designated as "limited partners".  The partnership agreement then makes the general partner responsible for managing the business of the partnership.  The limited partners are simply “silent” investors with no say in the business activities of the partnership.

Any income earned by the limited partnership are directed to and taxed in the hands of the partners, and any losses incurred by the limited partnership are allotted amongst the partners and may become a deduction from the taxable income of such partners.   A limited partner is restricted in their ability to deduct losses and in aggregate cannot deduct losses which exceed the amount they have invested.  This restriction can be less than the amount invested if the partner bought their interest from a former partner and not the partnership. (The ability of a limited partner to deduct losses is restricted and professional tax advice should be received with respect to such restrictions).

 In the event the limited partnership is unable to meet its obligations, only the general partner will be liable for the debts of the partnership.  The liability of a limited partner would be limited to the amount of capital the limited partner invested in the partnership.  However, if the limited partner participates in the management of the partnership, that partner would lose his or her "limited liability" and may become liable for the debts of the partnership, the same as the general partner.

Limited partnerships are used, for the most part, as a method for structuring tax driven investment ventures.  If the investment is tax driven, the limited partnership may have to register with Revenue Canada as a tax shelter.
 

Which type of business structure to use?

Deciding which type of business structure to use can be difficult.  Some questions to ask when choosing among various business structures include:
 

  • How easy and costly is the form of business structure to organize?
  • How much capital will the business need?
  • How much capital will come from owners and how much debt financing will be needed?
  • What are the tax implications of each business structure?
  • How much personal involvement should the owners have in controlling and managing the business?
  • How much risk and liability for the business should the owners assume?


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Sources:

Corman, Jeff and Murray Fulton. 1989. Patronage Allocation, Growth, and Member Well-Being in Co-operatives. Occasional Paper Series 89.01. Centre for the Study of Co-operatives: University of Saskatchewan.

Downey, W. David and Steven P. Erickson. 1987. Agribusiness Management 2nd ed. New York: McGraw-Hill.

Manitoba Industry, Trade & Tourism. 1997. Starting a Cooperative.  Cooperative Factsheet #613 dated December 1997.

Manitoba Industry, Trade & Tourism. 1997. Forms of Business Organization: Choosing a Form and Registering Your Business.  Forms of Business Org #109 dated May 1997.

Starke, Frederick A., Brian E. Owen, John A. Reinecke and William F. Schoell. 1987. Introduction to Canadian Business. Toronto: Allyn and Bacon, Inc.