First and foremost, congratulations on taking the leap to running your own business! This is a very exciting time and it is a glorious ride!
The following issues will be discussed in this post:
Types of business structures,
Cash flow and financing,
As a start-up, defined as a business that has been in operation for less than three years, you are joining the ranks of 2.4 million business in Canada! Over 53% of start-ups in Canada are run by part-time entrepreneurs, and many of these are started with seed money of $5,000 or less! You are not alone!
1. Type of Business Structures
We have all heard of the terms Sole Proprietorship, Partnership, and Corporation.
How are these different and Why are these distinctions important?
A. Sole Proprietorship
This is the simplest and least costly way to start.You can use your own name and existing bank account!There are no legal fees, other than registering your name and applying for a business license in your local jurisdiction.In BC, this will cost less than $100.
All income and expenses will run through your personal income tax return (T1 return) at the end of the year.For simplicity, your tax year end will be December 31st.Other dates *can* be chosen, but increases the complexity of tax reporting because you must “accrue” your income to December 31st anyways.
In addition, if you have a business loss, this will be applied against any other income that you earn, such as a salary from employment, to reduce your overall tax liability.
The downside to Sole Proprietorship?If your business is sued, your personal assets are on the line.
A partnership is “a relationship between persons who are carrying on business in common with a view to profit.”This can be between individuals (T1 return), corporations (T2 return), trusts (T3 return), or other partnerships.
While partnerships can be formed verbally, a formal written contract (ie. Partnership Agreement) is strongly recommended.
All income and losses are flowed out to the partners, who report their share of the partnership income on their tax returns.The partnership itself does not file an “income tax return”; however, certain partnerships are required to file an information return (the T5013 return).
A corporation is a separate and distinct legal entity from its shareholders and is identified with one of the following after its name:Corporation (Corp.) , Incorporated (Inc.), Limited (Ltd.).
It is more costly to set up and maintain.Incorporation can be done within your province of business or federally, if you plan to operate throughout Canada.While these can be done online for around $200, getting the advice of a tax professional and/or lawyer is recommended to ensure that your business is set up in the most tax advantageous way.
On-going costs would include annual legal filings and bookkeeping and accounting costs.While the latter costs are required for all three business types, the method of taking money out of the corporation (being salary or dividends) is more complicated and therefore, incurs higher accounting fees.In addition, the corporation must file its own income tax return (the T2 return) every year within six months of the year end.
Advantages of a corporate structure include a “corporate veil” that helps to protect your personal assets from your business assets in the event that the business is sued.You can choose any date for the corporate year end, often to coincide with your off-season when you have more time.Finally, there may be tax advantages because the basic small business rate in BC is 13% for 2017 (12.5% for 2018).
2. The Business Plan
A business plan helps clarify whether the business is viable. It forces you to research your idea:
Who are your competitors?
Will potential customers buy what you are selling?
Is your pricing competitive?
When starting your business, focus on sales! Try to sell your product or service before perfecting it. There is no point in developing something that no one is willing to buy.
Your business plan should be concise and contain pertinent information:
overall goals and objectives
the experience and qualifications of the key people involved (ie. management)
the advisors you will have on-board
your market strategy: research, strategy for attracting customers, pricing strategy
your projected cash flow and income and expenses for the first five years
3. Cash Flow and Financing
It is important to calculate your start-up costs, which includes buying long-lived assets (such as a computer and office/store furniture and fixtures) and considering your recurring costs, such as space rental.
You will be personally financing the start-up costs at the start, since the business won’t be making profits for a while. If you are considering getting a loan, remember to factor in the interest costs and required payments as well.
There are many sources of financing that are available, including:
equity – owners or shareholders can invest or buy shares in your corporation,
debt or loans – banks may require a business plan and may need a personal guarantee on the loan, since your business does not yet have income or assets,
grants – consider looking into business grants or SR&ED (Scientific Research and Experimental Development) tax credits. If your business is involved in innovation, the National Research Council of Canada (NRC) also provides financial assistance through its Industrial Research Assistance Program (IRAP),
crowd-funding – online funding, but you will lose a percentage of funds to the host (eg. Kickstarter), and
friends and family – a great source, but risk straining the relationship once money is involved.
DO keep your investors happy by keeping them in the picture! Give regular updates of your activities and share your financial statements.
DO keep your personal and business bank/credit accounts separate. This is so important!
DO use software to record your business transactions on a daily or weekly basis. Keep up-to-date!
DO issue invoices as soon as the work is completed.
DO keep on top of your accounts receivable.
DO keep some cash-on-hand to finance slow periods.
You can’t do everything. If you do not have the expertise, hire someone who does! Consider hiring consultants (rather than employees) so that you only pay for the time you use their services for.
Gaining experience for yourself is time-consuming and can be costly if you make mistakes. Consider hiring someone to help you, finding a mentor who can guide you, or perhaps gain some experience for yourself by working at a business that is already successful at what you want to do.
You will need expertise in sales, marketing, technology, bookkeeping…the list goes on. It is better to learn before you get too busy running the business.
There are two main types of tax: income tax and HST/GST.
It is recommended to register for GST as soon as you begin your business so that you can start claiming back the GST that you pay (these are called Input Tax Credits, or ITCs).
Regardless, you will need to register as soon as your company earns $30,000 for the year. Note that the registration can be back-dated to a maximum of three months.
Any income your business earns (in all three business structures) is reduced by any reasonable expenses that you have and are reported on your income tax return (ie. T1 personal return, T2 corporate return, or T3 trust return).
As previously mentioned, business losses in your sole proprietorship will be offset against other income in that year.
Business losses in a corporation can be carried back for up to three years or forward for 20 years, to offset income in those years.
DO keep all of your receipts and sales invoices for six years.
DO keep all long-term purchases or incorporation documents for “forever.”
Tips in Summary
Do your research. Have a Business Plan.
Start on a shoestring. Don’t over-commit, as cash-flow will be a real concern at the start.
Keep your business finances separate.
Keep up-to-date on your record keeping.
Gather experience before you start. Take courses, read books, or get help!
As always, contact OMNI if you have any questions or comments! Thank you for reading!