 Hello, it's Waylon Chow. Welcome to Business Entities Module 4, Part A. In this part, we will do an overview of the three basic forms of business organization and then focus in detail on the sole proprietorship. In this module, we will look at the three basic forms of business organization. The most basic one is the sole proprietorship. And then we'll look at the partnership and the various different types of partnership, which are the general partnership, the limited partnership, and the limited liability partnership. And the last type of or form of business organization that we'll look at is the corporation, or specifically business corporations. There are other types of corporations, such as non-shared capital corporations, which are used by not-for-profit or charitable organizations. We won't look at those, but we'll focus on only business corporations. Let's now do a high-level overview of those three basic types of business organizations. So let's have a look first at the sole proprietorship. The simple legal definition of sole proprietorship is one individual carrying on business alone. We have one owner carrying on business. So here's our sole proprietor right there, and our business is represented by this happy face. And this business has various dealings with outside third parties, such as customers, suppliers, or employees that it hires, various levels of government, including a Canada revenue agency. So the business, like any other business, has dealings with outside third parties. Now, the key legal aspect of a sole proprietorship is that the owner and the business are legally considered to be one and the same. So if, and we'll talk about this in further detail a little later, but if, for example, if the business owes money, because the owner and the business are one and the same, it's the owner that personally owes that money. Let's now have a look at the partnership. A partnership is considered to be one or more persons carrying on a business in common with a viewed profit. Legally speaking, it's considered to be a relationship and not a separate legal entity. So let's have a look. These are the two partners here. So they get together to carry on a business. So that is called a partnership. The partnership has dealings with outside third parties such as customers, suppliers, employees, governments, and CRA. And the key legal aspect of a partnership, just like with a sole proprietorship, is that the owners and the business are considered to be one and the same legally. So if, if the partnership owes money to someone, the, the partners themselves also personally owe that money. And now the corporation. The corporation is created by incorporating something called a corporation under a statute that's been created by either the federal parliament or provincial legislature. The corporation is considered to be on its own a legal person that's separate from its shareholders. So the owners are called shareholders. So it can be either one person or an unlimited number of people. In our example here, we have two shareholders. The two shareholders own shares in this separate legal person that's called the corporation. The corporation as a separate legal person has dealings with outside third parties. So again, the shareholders are the owners. The business is resides within this corporation, which is a separate legal person. So the key legal aspect is that the owners and the business are separate. That's what makes a corporation very different from either a sole proprietorship or a partnership. Here is a map of the different forms of business organization that we will be covering. For each of them, we will look at how it is formed, the key legal aspects, the financing of the business organization, the tax treatment and also how is it dissolved, the dissolution. The first type that we will be covering is sole proprietorships. How is a sole proprietorship formed? All it takes is one person starting the carrying on of a business and there you are. There's a sole proprietorship. There are no formalities that have to be completed to legally create the sole proprietorship. In other words, there are no forms to fill out, no registration to be done, and no fees to be paid to legally create the sole proprietorship. All it takes is that one person carrying on the business. However, there may be some formalities that are required to actually operate the business of the sole proprietorship. So these formalities could include getting a municipal business license and registering the business name. Consequently, it is very easy and inexpensive to get started as a sole proprietor as compared to a partnership and a corporation especially. A scenario that we will be working with throughout this module is called Lucy's Lemonade, which involves a little girl named Lucy who starts up a lemonade business. So we'll see her lemonade business evolve from being a sole proprietorship all the way to being a public corporation. So the basic scenario starts with Lucy deciding to sell lemonade in front of her house. So she sets up a little stand and makes a little sign offering lemonade for sale for 25 cents a cup. So what she's done is she has created a sole proprietorship. The two key legal aspects of a sole proprietorship are that the owner and the business are considered to be one and the same and that there is unlimited personal liability on the part of the owner or sole proprietor. The key legal aspect of a sole proprietorship, which I've mentioned before, is that the owner or in other words the sole proprietor and the business are one and the same. So that big concept has many different consequences. One consequence is that all profits and losses of the business belong to the sole proprietor and that has a secondary consequence in terms of how a sole proprietorship is taxed, which we will discuss a little later on. Another consequence flowing from the concept that the owner and the business are one and the same is that the sole proprietor is personally responsible for all of the legal obligations of the business, including all the contracts entered into in the course of the business and any torts that are committed in the course of the business by either the sole proprietor or any employee of the sole proprietorship. If you remember when we dealt with torts, the concept of vicarious liability for an employer can be vicariously liable for torts committed by an employee in the course of their employment and also tax liabilities. If the business owes tax, then the owner being the sole proprietor is the one that is actually responsible or liable for that tax. Because the owner and the business are one and the same, the sole proprietor, the owner has what we call unlimited personal liability and that's a huge disadvantage when operating using a sole proprietorship. What unlimited personal liability means is that since all of the business obligations are the personal obligations of the sole proprietor, all of the sole proprietor's assets, whether they be business assets or personal assets, are at risk from claims by business creditors. So if a business supplier sues the business, the sole proprietor is personally liable for that debt to the business supplier. The supplier can obtain a judgment from a court and enforce that judgment by seizing the assets of the sole proprietor. Those assets that could be seized are not just the assets that are used in the business but can include any of the sole proprietor's personal assets such as a house or a car or anything that's owned personally by the sole proprietor. Lucy, in her lemonade business, has decided to hire her little sister Marcy to help her with the lemonade stand. She pays Marcy 25 cents per hour. Marcy makes a batch of lemonade but mistakenly mixes in some powdered detergent instead of sugar. Lucy sells a cup of this lemonade to Charlie. Charlie drinks it and becomes so ill that he has to be hospitalized. He does thank goodness recover but once he's recovered, he sues Lucy for damages of $100,000. So is Lucy liable to Charlie since it was Marcy that put the detergent in the lemonade? So please pause the video so you can consider this question. Lucy is personally liable as the sole proprietor. Lucy is liable because she is vicariously responsible for the negligence tort that was committed by her employee Marcy. So because of vicarious liability and because Lucy is a sole proprietor, she is personally liable for the $100,000 of damages that may be owed to Charlie if he's successful in his lawsuit. So let's say Charlie wins that lawsuit and obtains a judgment of $100,000 against Lucy. The business assets of Lucy's lemonade consists of just a few pictures and utensils worth $20, some inventory which is bottles of lemon juice worth $15, and two folding chairs worth $3 and no cash. But also Lucy has a personal bank account with a balance of $5,000 that she is saving for a university. So the question here is, if Lucy cannot pay the $100,000 judgment, what assets can Charlie go after to satisfy the judgment? So please pause the video at this point so you can consider this question. Charlie can go after any or all of Lucy's business assets and personal assets, including the cash in the bank account. So that has to do with the fact that the owner and the business for a sole proprietorship is one of the same. Lucy is personally responsible and she has unlimited personal liability for the debts of the business. Where does the financing for a sole proprietorship come from? Since there is only one owner, the capital for the business has to come from the sole proprietor. Now where does the sole proprietor get the capital from? So one source is from savings. Another source is to sell or contribute assets that he or she already owns. The sole proprietor may also borrow money from a lender which could include a bank or friends and family. For example, the sole proprietor may already own a house that they live in. So they could get a mortgage against that house to get a loan from the bank. How is a sole proprietorship tax? So let's remember our key legal aspect being that the owner and the business are one and the same. So that means that any business income or business losses belong to the sole proprietor. So if there are business profits, they are considered to be the personal income of the sole proprietor and get reported on the sole proprietor's personal income tax return and are subjected to the personal tax rates that apply to the sole proprietor. And in Canada those personal tax rates sometimes could be higher than rates that would apply to income earned by a corporation. So that is considered to be generally a disadvantage of being a sole proprietorship. An advantage however is when the sole proprietorship has business losses. Those losses just like the profits belong to the sole proprietor and they get reported on the sole proprietor's personal income tax return. But it's an advantage from a tax standpoint because those business losses can be used on that tax return to reduce other personal income of the sole proprietor. So the effect is that the net income of the sole proprietor is reduced by those business losses and the less net income you have on your income tax return the less tax you pay. So the usual strategy that many businesses use is that when they start up most new businesses expect to have a loss in their first few years, in their startup years. So it's usually beneficial from a tax standpoint at least during those first few startup years to operate the business as either a sole proprietorship or a partnership. And we'll talk later on that partnership has this same tax advantage. So in those startup years we operate the business as sole proprietorship or partnership so that the owners of the business are able to claim the business losses on their personal tax returns. And then once the business starts earning a profit, we can easily convert the business from either a sole proprietorship or a partnership into a corporation to take advantage of lower corporate income tax rates and other various tax advantages. Since a sole proprietorship is not a separate legal entity, when the sole proprietor dies the sole proprietorship comes to an end. It cannot go beyond the death of the one owner. Any business assets or liabilities that exist at the time of the death of the sole proprietor get automatically passed on to the estate of the sole proprietor. The estate will take care of paying those liabilities and any other liabilities that the sole proprietor had at the time of his or her death. And if there are any assets remaining after those debts are paid the assets will pass or be transferred to the people named in the will of the sole proprietor.