Chapter 3 – Making your Business a Reality
Now that you have decided that starting a business is for you, it is time to make your desires a reality.
Making the decision that you want to be an entrepreneur is the easy part. You now need to start thinking about how you want to create your business.
You have taken the first steps towards getting into business. Your next decisions are:
- Choosing how to get into business (starting from scratch, buying an existing business or buying a franchise).
- Choosing the type of business (proprietorship, partnership or a corporation).
Ways to get into Business
There are three common ways to begin a business:
Each choice has its own advantages and disadvantages. You will have to evaluate before starting your own business.
A key factor in choosing which way you want to start a business is risk, or your perception of risk. If you are an experienced businessperson, you may want to start from scratch. If you are inexperienced or want to reduce your risk, you may want to buy an existing business or a franchise.
In making your choice, you should consider the risk/return trade-off (the higher the risk the greater the return) and your personal risk tolerance. A business start-up takes the most time and faces larger risks, but the returns may be higher. When making your decision, be sure to assess your:
- Tolerance for risk.
- Knowledge of business.
- Time frame: it takes longer to start your own business.
- Understanding of the market environment: by buying out your competition you are gaining their customers.
- Amount of personal resources you have to invest in the business: it costs more to buy an existing business or a franchise.
- Desire to make your own decisions.
Starting from Scratch
This is the route chosen by most first-time entrepreneurs. Risks tend to be highest in a new business, but so are the potential rewards. Starting a business often means long hours doing everything from waiting on customers to filing, bookkeeping and sweeping the floors.
During the start-up you will be doing things you never dreamed of, yet the satisfaction you get from a successful start-up will make that effort worthwhile.
Considerations for Starting from Scratch
- Potentially lower start-up costs and lower overhead.
- Freedom to make your own decisions (marketing, pricing, and product selection).
- Flexibility to change quickly.
- High risk.
- Increased planning and development time.
- Need to develop new clientele.
- Need to develop new systems and processes, supplier contacts, etc.
Buying an Existing Business
If you are a first-time business owner, buying an existing business offers an excellent way to reduce risk. However, you must be very careful to pick the right business for the right reason at the right time. Before purchasing a business, you must answer the following questions:
- Why is the business for sale?
- Is the asking price justified?
- Are you paying for assets that you will not need?
- Do you have the skills needed to operate the business?
To make sure you make the right decision you should:
- Have an accountant review the financial statements and estimate what the business is worth.
- Get an appraisal of the assets and equipment.
- Check out the age and amount of the inventory.
- Check out liens, leases, employee contracts and other contracts that may be in place.
- Talk to suppliers and customers.
- Seek legal advice.
Considerations for Buying an Existing Business
- Less risk than starting from scratch.
- Supply and service systems in place.
- Established client base.
- Immediate cash flow.
- Higher cost than starting from scratch.
- Less flexibility: existing contracts or agreements may limit future actions.
- Clients and suppliers may already have opinions of the business.
- Established organizational culture may be difficult to change or slow to adapt to new ways of doing business.
- Liabilities may exist relating to warranties, government regulatory infractions or tax reassessments.
Buying a Franchise
A franchise agreement allows you to sell the franchiser’s goods and services in a specific retail space or geographic area. Franchising has become a very successful way for many entrepreneurs to get into business because most franchises are based on a winning formula. Franchises work because market assumptions have been proven. Supplier and distribution networks are normally in place, as are training and orientation programs.
The arrangement is covered by a contract. The franchiser usually charges an initiation or start-up fee, plus royalties on sales. The package may include such items as:
- Established national/regional marketing campaigns.
- Leasing, employee training and use of trademarks.
- Predesigned buildings and layouts.
- Management training programs.
The degree of control retained by the franchiser is not the same for all franchises. Before entering a franchise agreement, you should make the same careful analysis that you would for any other type of business. You must bear in mind that although franchise owners are self-employed, they must conform to someone else’s pattern of doing business.
The requirement to follow a formula may limit personal freedom and business experimentation. You should know in advance if your personality and motivation are a good match with such a structured form of doing business. The Canadian Franchisers Association (most of Canada’s leading franchisers are members) can provide valuable advice and assistance.
Considerations for Buying a Franchise
- Lower risk.
- Proven formula.
- Total business package.
- Brand recognition because of national or regional marketing campaigns.
- Market protection.
- Existing supplier/distribution networks in place.
- Expensive to start.
- Ongoing royalty payments.
- Standard products and processes with little opportunity for experimentation.
- Your market size may not be large enough for the franchise to be considered.
- Franchise policies and procedures must be followed.
Types of business organization
There are four basic types of business organization:
- Sole proprietorship
A sole proprietorship is a business owned by a single person. It is the most basic business structure and is usually owner-operated. It is the easiest and simplest type of business to set up, organize and manage. It is not subject to as many regulations as other business structures.
With this type of business organization, you would be fully responsible for all debts and obligations related to your business and all profits would be yours alone to keep. As a sole owner of the business, a creditor can make a claim against your personal or business assets to pay off any debt.
A sole proprietorship may be operated under the owner’s name, without registering the name with Corporate Registries, Department of Justice. If a business name is used or more than one owner is implied (i.e. ‘and Company’ or ‘and Son’), the name must be registered with Corporate Registries.
- Easy to set up.
- Less expensive to start.
- Owner has complete freedom of operation and control.
- All profits belong to the owner.
- Business expenses may be deductible from personal income for tax purposes.
- If your personal assets are limited, you may not always have the required capital to meet business needs. Funders may be reluctant to help.
- In the case of business failure, the owner’s personal assets, including home and properties are subject to claim by creditors. The owner assumes all risks, accepts all profits and losses, and pays all taxes.
- Legal life of the business terminates with death of the owner.
- Profits are taxed as personal income. If profits are high, you may pay higher taxes than you would if you were incorporated.
A partnership would be a good business structure if you want to carry on a business with a partner and you do not wish to incorporate your business. With a partnership, you would combine your financial resources with your partner into the business. You can establish
the terms of your business with your partner and protect yourself in case of a
disagreement or dissolution by drawing up a specific business agreement. As a partner, you would share in the profits of your business according to the terms of your agreement.
You may also be interested in a limited partnership or a limited liability partnership (LLP). See chapter 9 for more details.
When establishing a partnership, you should have a partnership agreement drawn up with the assistance of a lawyer, to ensure that:
- You are protecting your interests.
- You have clearly established the terms of the partnership with regards to issues like profit sharing, dissolving the partnership and more.
- You meet the legal requirements for a limited partnership (if applicable).
In addition, the Partnership Act requires you to register the business name, address, type of business and partners of the firm with Corporate Registries, Justice, within 60 days of its formation.
- A partnership is easy and inexpensive to start and is also flexible.
- Provides additional sources of capital for the firm by combining the assets of two or more partners.
- Provides more resources and expertise to perform the functions of the company.
- A partner can be held personally liable for all debts incurred by the business (unless limited partnership).
- Each partner is responsible for obligations placed on the business by other partners.
- Profits are taxed at personal tax rates.
- The company ends with the death of any partner.
When you incorporate your business, it is considered to be a legal entity that is separate from the owners. As a shareholder of a corporation, you will not be personally liable for the debts, obligations or acts of the corporation.
The act of incorporation gives life to the business. The terms corporation, incorporated company and limited company all mean the same thing. A corporation can acquire assets, go into debt, enter into contracts, sue or be sued, and even be found guilty of committing a crime.
The owners of the business are called shareholders and generally have no personal liability for the company’s debt, unless they have signed a personal guarantee. However, if a shareholder is also a director of the company, they may be liable.
A company’s money and other assets belong to the company, not the shareholders. The profits of the corporation may be retained for reinvestment or distributed to the shareholders in the form of dividends.
- A corporation has limited liability and is a distinct legal entity apart from the owners (shareholders). Generally, shareholders are not held personally liable for the debts, obligations or acts of the company except to the extent of their actual
investment. Directors are the exception and may be liable.
- The life of the company does not end with the death of a shareholder.
- Ownership can be transferred by the selling of shares.
- Capital may be accumulated from the sale of common or preferred stock, loans or by retaining profits from the business.
- Incorporated companies may be subject to beneficial tax rates.
- The fees required to establish and maintain a corporation.
- Activities are limited to those specifically granted by the company’s articles of incorporation.
- The corporation is subject to more regulations.
- In a small corporation, shareholders may have to sign personal guarantees to funders, increasing their liability and risk.
A co-operative is a special type of business that is owned and controlled by its members. Each member pays a membership fee or purchases a membership share and has one vote regardless of how much money they have invested in the co-operative. Some cooperatives may pay out patronage dividends according to the amount of business done by the member.
The purpose of a co-operative is to unite those in similar circumstances and with common goals to gain the advantages of large-scale operations. The NWT Co-operative Associations Act stipulates that co-operatives must be incorporated and contain the words “co-operative” and “limited” in their name. Co-operatives are subject to income tax in the same manner as other corporations, although a deduction from income may be claimed for patronage dividends paid to members and customers.
- Social and educational needs may be served by the pooled effort necessary to operate a co-operative.
- Community development in remote areas may be stimulated through the
formation of co-operatives.
- Life of the co-operative does not end with the death of a member.
- The collective buying power of a cooperative is greater than that of the individuals who make up the co-operative.
- Members having the larger investment have the same voting privilege as smaller contributors.
- Because of their democratic form and social and educational objectives, often business decisions may be made for reasons other than return on investment.
To incorporate or not? Key considerations
The various types of business organizations offer different levels of protection for you, depending on your investment and personal net worth.
Some of the factors you should consider when choosing your type of business organization include:
- Ease of entry (the cost and red tape involved).
- Degree of regulation and reporting.
- Need to protect non-business assets and to limit personal liability.
You may wish to hire an accountant or a lawyer to help you evaluate the best options. Various branches and agencies of the federal and territorial governments can also help you to choose the right type of business organization.