Starting a Small Business (No. 265)
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There’s a lot to be said for starting your own small business. You can be your own boss, and if it goes well you'll have the satisfaction of having created something of value. But statistics show that small businesses have a high failure rate too. Often it's because of inadequate or unrealistic business planning. This script discusses some of the legal aspects to starting a business that you should consider.
Three ways to start a business
- buy an existing business
- buy a franchise
- start a new business
Buy an existing business
You can buy either the shares of a business or the assets. Buying the assets is usually less risky. Both options have pros and cons. You should discuss the options with a lawyer and an accountant.
The advantages of buying a business include loyal customers (an existing brand and goodwill), trained employees, reliable suppliers, and fully equipped premises. Sometimes the seller will stay on for a while until you learn the business.
But you pay for these benefits—buying a business usually costs more than the alternatives. Be careful that you get what you have been promised and are paying for, without any hidden liabilities. Investigate the business and its assets to ensure there are no liens or third-party claims on the business or its assets. Ensure the assets are in good working order. Start early because this due-diligence process takes time to complete and you need to verify these things before you finalize the deal.
You might want the seller to sign an agreement promising not to compete with you, recruit your key employees, or use confidential information about your business.
All these things should be covered in a written purchase agreement. If you're thinking of buying a business, consult your lawyer early—before making an offer—to protect yourself. Then you can still negotiate the deal you want, based on all that you have learned about the business.
Buy a franchise
A franchise is a common way to start a business. It’s a system for distributing and marketing a product or service, such as the right to sell a certain brand of fast-food hamburgers or a dollar store. Sometimes financing and training are supplied, so a franchise can be a good turnkey operation. Usually you must buy goods or services from the “franchisor” (the person or company who grants you the franchise) on an on-going basis, as well as pay for your initial investment. And there are almost always restrictions on how you run the franchise. Sometimes these are so strict that you're the boss in name only. And there's a danger that you may end up paying substantial royalties or supply premiums. Also, franchisors often require a deposit to apply. Don’t give the deposit until you’re sure you qualify for the franchise.
If you're thinking of a franchise, check its reputation in the business community, and have your lawyer examine the agreement before you sign. Depending on the franchise, some terms of the agreement may be negotiable, so you may be able to do better than what the franchisor first offers you. On the other hand, many terms of franchise agreements are not negotiable (unlike agreements to buy a business). So be sure that the franchise business model will work for you before you are legally bound.
Start a new business
There are pros and cons to starting a new business. It’s usually less expensive than buying a franchise or existing business. But on the other hand, you don’t get any support from a seller or franchisor. So you start with no customers, and you may lose money while starting up.
If you start from scratch, you must decide what form of business to use:
- a sole proprietorship
- a partnership
- an incorporated company
There are advantages and disadvantages to each of these. What’s best for you will depend on your circumstances.
This is the simplest form of business. It has several advantages:
- It’s the least expensive form of business to set up.
- You don't have to share the profits with anyone.
- Decision-making is quick and management is relatively easy—there's no one to consult but yourself.
- You can do business under a business name even if you’re a sole proprietorship. For example, as John Smith, you can do business under the name of “The Sandwich King.” (But make sure you’ve registered the name before using it.)
But there are disadvantages too:
- If you die, the sole proprietorship comes to an end.
- You have unlimited personal liability for the debts of the business, so if the business fails, you may risk losing your personal assets, such as your house and car.
If the business makes money, it will be taxed as your personal income—you don't get the benefit of the lower, small-business tax rate. On the other hand, as many businesses don’t make money in the first few years, you’ll have tax deductions you can use personally. A good rule of thumb is to save a percentage equal to your potential taxes so that you don’t have a large tax bill at the end of the year. If you start with a sole proprietorship and things go well, you can always incorporate a company later and transfer the business to the company. Then you get the benefits of carrying on a business through a company instead of personally. This is called a “roll-over” in tax language.
A partnership combines the talents and resources of two or more people to suit the needs of a business. A partnership agreement setting out each partner's rights and responsibilities is very important, and you should take the time to develop one before you start the partnership.
But there are disadvantages to a partnership. As a partner, you’ll be personally responsible for all the debts of the partnership and, generally, you'll be bound by the acts of your partners, even if you don't agree with them.
The biggest disadvantage of a partnership is joint liability. Any partner can be held wholly liable for the actions of another partner who acted within the scope of the partnership and incurred liability. A limited liability partnership (LLP) can limit your liability for another partner’s actions. You should discuss it with a lawyer. Script 266, called “Forming a Partnership” has more on this.
For tax purposes, each partner treats their share of the partnership's profits as personal income.
For more information on partnerships, check Script 266 on “Forming a Partnership”.
A company is a separate legal entity from its owners. A company is liable for its own debts, owns its own property, and can sue or be sued. Its owners, called shareholders, enjoy limited liability. This means that their personal assets are generally not at risk and they are not personally liable for the company’s debts. They risk losing only their initial investment to buy shares and any shareholder loans they made to the company.
But sometimes this isn't as good as it sounds. Lenders often insist that shareholders of small companies personally guarantee the company's debts, so the lender is sure of getting repaid even if the company can't pay. And in some cases, a shareholder may be personally liable for a company's debts. Shareholders are not required to provide any work or services for the company unless there’s a contract requiring them to. You should have a shareholder’s agreement to deal with these topics. A lawyer can help with that.
If you incorporate, you must use the words “incorporation,” “limited” or “corporation” (or Inc., Ltd., or Corp.) after the company name.
You can incorporate federally or provincially. If you’re going to do most of your business in BC, you should incorporate in BC, as it’s much easier in the long run. Companies that incorporate federally must register extra-provincially in each province they do business in. A company files its own separate tax return and pays its own tax. Shareholders pay tax on what they receive in dividends, bonuses or salary from the company. Depending on your personal income level, you might be able to save tax by incorporating.
In addition to filing tax returns, each year a company must file either provincial or federal corporate returns with the corporate registry in the jurisdictions where it operates.
For more information on incorporating a company, check Script 267 called, “Forming a Private Company”.
You’ll need a business licence and name approval
Whatever form of new business you choose—sole proprietorship, partnership or company—you’ll need to get a business licence and name approval. You get a business licence from your town or city hall, and the cost will vary depending on the type of business and whether it's operated from commercial or residential premises. You can get the name approval from the provincial government. Many banks won’t give you financing until you have a business licence and name approval.
Other government regulations and requirements may apply
- Licences and registrations: Some businesses cannot be carried on at all unless you’re legally qualified to do so. For example, you can't start up a real estate agency unless you’re licensed. So make sure you have any special licenses or registrations required for your particular business.
- Employee rules: If you have employees, you’ll have to set up accounts with the Canada Revenue Agency (CRA) for withholding taxes, Canada Pension Plan (CPP) deductions, and Employment Insurance (EI) premiums. You may also have to set up accounts for GST and Provincial Sales Tax payments and Workers Compensation payments.
- Zoning and bylaws: Do you know where your business will be located? Some types of business can't be operated in certain areas because of zoning by-laws. If you're planning to run your business from home, check the by-laws at your local city hall, and if you live in a condominium, look at the strata corporation by-laws. As for commercial premises, just because someone is willing to sell or rent space to you doesn't mean that the property meets all zoning requirements for the business you have in mind. Check this out yourself at your town or city hall before you sign a lease.
- Building permits: If you're going to renovate the premises, you'll need a building permit. If you're renting commercial space, you'll probably have to pay at least a share of all municipal taxes on the premises, including a business tax, over and above your rent. Get your lawyer to review your lease agreements before signing them.
- Other regulations: Depending on the business, regulations may apply to your product or service. For example, some products have labeling requirements and door-to-door sales are regulated.
- Consents from third parties: When buying the assets or shares of a business, the purchase may require third-party consent and approval. For example, if the business operates from leased premises, the landlord will need to agree to the sale and transfer (assignment) of the existing lease to a new lease with the new owner. The buyer and seller of the business should not assume the landlord will automatically agree.
- Small Business BC has information and guides on starting a business. Call 604.775.5525 in Vancouver or 1.800.667.2272 elsewhere in the province.
- Innovation, Science and Economic Development Canada has information and guides on starting a business, incorporating a federal company, patents, taxes, and so on.
- Check the provincial OneStop Business Registry website which lets you apply for various business licences and registrations at one time. It also refers you to “kiosks” where you can get a real person to help you. The OneStop Help Desk number is 250.370.0332 in Victoria or 1.877.822.6727 elsewhere in BC.
- For more information on incorporating a BC company, check the BC Corporate Registry website.
- Your lawyer, accountant or bank manager can advise you on certain matters. Many school boards and colleges offer seminars on starting a business. Your public library has a wealth of information including trade directories and information on sources of government assistance.
- Finally, talk to other people who have started their own business.
[updated July 2018]
The above was last reviewed for accuracy by Oliver Hamilton and edited by John Blois.
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