14 September 2012
CHAPTER 10: FORM OF ORGANIZATION AND LEGAL
FORMS OF ORGANIZATION
1. The Soles Proprietorship Option - is a business owned by one person. The business
owner receives all the profits, but is also subject to unlimited liability.
The death of an owner terminates the legal existence of a business. Sole proprietorships
are able to deduct normal business related expenses from income for tax purposes.
2. The Partnership Option – a legal entity based on the voluntary association of two or
more persons to carry on, as co-owners, a business for profit. Partners share the
profits and are also subject to unlimited liability.
Partnership should be formed only it if is the best option when all matters are considered.
The following questions should be asked before creating a partnership:
What is our business concept? (Roles of the partners and how business will be done?)
How are we going to structure ownership? (Share ownership between the partners)
Why do we need each other?
How do our lifestyles differ? (Family, Single?)
Partnership Agreement – a document that states explicitly the rights and duties of
Agency Power – the ability of any one partner to legally bind the other partners.
Death, incapacity, or withdrawal of any one partner ends a partnership and necessitates
liquidation or reorganization of the business.
Limited Partnership: a partnership with at least one general partner and one or more
The General Partner – a partner in a limited partnership who has unlimited personal
Limited Partner – a partner in a limited partnership who is not active in its management
and has limited personal liability.
3. The Corporation Option – is a business organization that is owned by shareholders
or stockholders who share in the profits and losses generated by the firm and are
provided limited liability. Corporations are legal entities.
Legal Entity – a business organization that is recognized by the law as having a separate
legal existence. This means that a corporation can sue and be sued, hold and sell property,
engage in business operations and pay taxes separately from its owners.
Articles of Incorporation – the document that establishes a corporation’s existence,
which is granted by federal or provincial ministry. 14 September 2012
Share Certificate – a document specifying the number of shared owned by each
shareholder. Ownership of shares typically carries a pre-emptive right, or the right to
buy new shares, in proportion to the number of shares already owned, before new shares
are offered for public sale.
The owners of a corporation benefit from limited liability, however some banks require a
promissory guarantee before they lend the money. In this case, the limited liability
benefit of the corporation is lost. The court may also override this principle in some
Ownership in a corporation is readily transferable. Arrangements should be made in
advance, in order to have clear expectations of what happens to the shares of the partners,
in the event of retirement or death.
CHOOSING AN ORGANIZATIONAL FORM
1. Initial Organizational Requirements and Costs: Organizational requirements and costs
increase as the formality of the organization increases.
2. Liability of Owners: A sole proprietorship and partnerships have a disadvantage of
unlimited liability, where a corporation does not. However, if a corporation is small,
its owners are often required to guarantee a loan personally.
3. Continuity of Business: Corporations have indefinite life time, where sole
proprietorship or general partnerships are terminated on the death or withdrawal of
any one partner. (Unless stated otherwise)
4. Transferability of Ownership: Ownership is transferred most easily in the corporation.
5. Management Control: A sole proprietor has absolute control of the firm. Control
within a partnership is normally based on the majority vote. Within a corporation,
control is split between the shareholders of the company and the board of directors
who manage daily operations of the business.
6. Attractiveness for raising capital: A corporation has an advantage when raising new
equity capital. In contrast, unlimited liability of partnerships and sole proprietorships
7. Income Taxes: One of the major considerations when choosing a form of organization.
THE BOARD OF DIRECTORS
Board of Directors – the governing body of a corporation, elected by the shareholders. It
elects the firm’s officers, who manage the enterprise with the help of management
The use of board of directors is becoming increasingly attractive due to a growing
complexity of small businesses – resulting from globalization and technological advances.
Objectivity is a particularly valuable contribution, and hence some small businesses
employ outside directors.
Some of the contributions of board of directors includes: Review policy decisions,
provide general direction, monitor the firm’s ethical behaviour, mediate and resolve
disputes among top management. 14 September 2012
An advisory council – a group that functions like a board of directors but acts only in an
advisory capacity. (An alternative to board of directors.)
FEDERAL INCOME TAXES AND THE FORM OF ORGANIZATION
Sole Proprietorship: self-employed persons are taxed on their business incomes at tax
rates set for individual.
A sole proprietor and partnership reports the income it earns to Canada Revenue