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Understanding the right structure for growing your business
By ATB Financial 7 September 2020 7 min read
Like many new entrepreneurs, Holly Singer was quickly getting used to the long work hours as she toiled around the clock to establish her then fledgling enterprise Milk Jar Candle Company.
A former nursing student, Singer hit upon an innovative idea to produce eco-friendly artisan candles, stunning in design as well as clean-burning. What had been originally intended as a small side-business, “something creative on the side” to earn a few bucks for school, instead proved a major success right off the bat. In a few months, Singer, who manufactured all of the candles from her kitchen table, had completely sold out of Milk Jar’s modest initial allotment. To her surprise and delight, business was booming.
But success came with a grueling workload. Nearly half of Alberta business owners report working as many as 60 hours a week to keep their enterprises afloat while only getting around five and a half hours of sleep a night, and Singer was no different, spending virtually all of her waking hours attempting to satisfy the unceasing demand for her products. She was initially reluctant to seek outside help.
“This was such a little baby of mine and it was, like, my whole craft,” said Singer, who recently expanded the Calgary company into its own dedicated factory workshop. “As Milk Jar got bigger, I was working really long days, and I was so scared to have someone help me.”
A sole proprietor or simple partnership- Milk Jar when it was first established by Singer for example- is the most basic of business structures.
The evolution of your business structure
More complex business structures such as corporations or limited liability partnerships are considered legally distinct from ownership and have clearly defined organizational structures, as well as more demanding legal and financial regulation. Such entities might be required, for example, to establish a board of directors and issue company shares to establish ownership.
Business educator Jason Bacon coaches and works with startups on behalf of ATB. An entrepreneur and advisor to entrepreneurs, Bacon appreciates the apprehensions of business owners when it comes to evolving their company’s structure. Particularly when that often means ceding some control of the business they’ve toiled to build.
But resisting such change, he believes, can directly impact how large the company grows.
“It comes down to growth potential in my mind,” says Bacon. “At some point you will need to transform into a different business structure to continue to grow. If you don’t, then there could be large inefficiencies in your business. Maybe you’re paying too much in taxes, or have too much personal liability. It may even impact your ability to sell your business.”
Structuring to remain agile in a shifting business landscape
Let’s say a sole proprietorship wants to expand and open a new location. Financing a venture like that, unless the owner is independently wealthy, will require a sizable investment through a bank loan or investor funding.
Faced with this financial hurdle, the small business owner, according to Bacon, is at a disadvantage when it comes to flexibility, compared to a more sophisticated business structure.
A sole proprietor may need to personally guarantee a loan and provide collateral. Some corporations, if new enough, will still require a personal or limited guarantee. As they grow bigger, that may not be a requirement. This could be determined by both size and relationship with their financial institution.
“You have more options with a diverse structure,“ says Bacon. “It gives you more flexibility for growing the business.”
The tax factor
Taxes are another factor to consider in determining the ideal structure for your business. In the case of a sole proprietorship, income (or losses) of the business are reported on the individual’s personal income tax return. This can be beneficial in the start-up phase when many businesses generate losses, as these business losses can be used to offset other sources of income. For a highly profitable business, however, this can result in large annual tax bills as the top marginal personal tax rate in Alberta is currently 48 per cent. Similarly, income (or losses) allocated from the partnership are reported on the partners’ tax returns.
In contrast, a corporation is taxed separately from its shareholders, with generally only the salaries or dividends paid to shareholders being reported on the shareholders’ tax returns. Where profits from an operating business are retained within the corporation, this can result in significant tax deferral. This is because the combined federal and provincial small business tax rate in Alberta of 11 per cent is far lower than personal tax rates.
Structuring to effectively reduce risk
The same principle is recognized when it comes to liability. As her company established itself as a viable business, Singer grew more receptive of the advice she was hearing.
She ultimately decided to incorporate Milk Jar upon learning of her vulnerability, in the event of a court judgement against the company, as a sole proprietor.
“I was chatting with a lawyer who said, ‘you should incorporate immediately, you make candles that could burn someone's house down and potentially get you sued, you could lose everything you built’,” recalls Singer. “I was very convinced.” Singer’s experience solidifies the value in engaging with your strategic legal, financial and accounting partners to evaluate and weigh all of your options and make the right decision for your business.
A sole proprietor is inextricably linked to the company name and is fully liable for court judgments against the business. An incorporated business, on the other hand, is usually considered a separate “person” from the business-owner, with its own distinct assets and liabilities. In most situations, business-owners are not personally responsible for the liabilities of their incorporated business, with some exceptions.
Shifting liability from a person to a corporation could also help the business safeguard assets which otherwise could be forfeited. Some businesses have chosen to restructure operations as separate entities to ensure patents or trademarks are protected in the case of a negative court judgement.
Some professions incorporate, says Bacon, particularly due to liability concerns. Some industries require mandatory incorporation.
Documenting your structure
When switching structures there will always be legal requirements such as the drafting of “guiding documents”, which essentially provide a road map for how the new business entity will function.
Bacon strongly recommends adding to those considerations a unanimous shareholder agreement for a corporation and a partnership agreement for a partnership. This dictates the rules of the relationship and ensures all owners are held accountable so there’s a clear understanding of what’s expected from all parties. Such agreements are vital, says Bacon, for complicated scenarios like a buyout or dissolution of the enterprise.
Beyond taxes and liability issues, another benefit from moving to a new structure is a chance for the company to boost its growth potential. While accessing debt financing will depend on the overall financial health of the company regardless of its structure, corporations can access equity financing, though often the expected return by an equity investor is higher than the rate of a bank loan.
The nuances of financing can be complex depending on the needs, structure and health of your business. A strategic financial partner will be key to helping you weigh your options and making the best financing decisions for your business.
A shift in structure might also prove more attractive to a potential investor, who could be offered company shares, voting rights or some other perk a sole entrepreneur can’t potentially provide.
Switching business structures comes down to many factors and not all business owners may be familiar with the legal and administrative requirements. Bacon strongly recommends turning to a professional - lawyers, accountants, bankers and other experts - to avoid missing any important details and to fully understand all of the implications of restructuring the business.
Ultimately, the decision to shift structures rests with the business owner.
“As an entrepreneur you need to be able to take all the advice you are receiving and look at your business as a whole, and then make a decision,” says Bacon.
If you’re looking for a deep dive on everything you need to know around how to grow your business, our ATB X Accelerator program might be just the place for you. Alternatively, feel free to reach out to one of our entrepreneur strategists to explore where you are with your business, where you want to be, and how to get there!