GOING OUT ON YOUR OWN?

When setting up your business or restructuring your current business, there are many things to consider – one of them being what entity structure to go with

Before you begin the exercise of picking a business structure, you need to ask yourself a few questions:

1. Will you be looking for investors?
2. Are you wanting to grow the business?
3. Will you want to sell the business in the future?

In this article, we examine the most common structures and their legal consequences.

Limited Liability Company

This is the most common form of business entity in New Zealand. A limited liability company is a legal entity separate from the people who own and run the company (eg, the director(s) and shareholder(s)). Companies are governed by the Companies Act 1993, their constitutions (if they have one) and the common law that applies to all businesses.

Advantages
The main advantage of a company is it provides its owners (eg, shareholders) with limited liability to creditors. This encourages investment, as the risks for shareholders are greatly reduced. This limited liability is often circumvented by creditors (such as banks) requiring personal guarantees from the individuals involved.

Directors have duties to the shareholders and creditors and can be held personally liable for company debt in certain situations, such as trading while insolvent, or if they have given personal guarantees. It is therefore important that directors understand the responsibilities of their role.

Structuring the business as a separate legal entity also makes it easier to sell. The business is not specifically tied to individuals and can continue to operate indefinitely. It is easier to obtain funding and investment, which is necessary for a business to grow.

Disadvantages
Incorporating a company is more complicated than other business structures, as it bears legal and financial obligations. For example, you must file annual returns in both the Companies Office and with Inland Revenue, and different tax obligations apply. There is more regulation, and consequently more paperwork and costs associated with operating a company. Conversely, this gives the business credibility.

Sole Trader/Proprietor

A sole trader structure is commonly used for small businesses. It simply involves an individual operating a business. A sole trader will need to comply with legislation and common law that applies to businesses generally.

Advantages
This structure is straightforward because there is no separate legal entity from the operator. The start-up costs are low and
it is easy to set up.

As a single person owns the business, there is little cause for friction or disputes over the operation of the business. The sole trader controls the business and gets all the profits. It is also possible to offset losses against other income.

Closing a business is very simple and can be carried out at little cost.

Disadvantages
The key disadvantage of the sole trader structure is that an owner’s personal liability is unlimited. The owner is personally liable for any business debts or losses, including taxes. All of their assets, such as their family home and other personal bank accounts, are vulnerable to claims arising from the business. Operating as a sole trader can therefore be risky without the right asset protection (such as a family trust) and insurance in place.

It is more difficult to grow a sole trader business because it is harder to get loans and attract investment. It can also be difficult to sell as a working business due to the links to an individual.

Partnership

A partnership is established when two or more people or organisations form a business. This is a popular structure for professionals such as architects and lawyers. In a formal partnership, the partners set out in an agreement how the profits, debts and work will be shared. However, a partnership can also be informal and unincorporated.

Advantages
A partnership allows for the sharing of responsibilities and expenses when running a business. In a partnership you can work collaboratively with others
and it enables each partner to specialise
and diversify; growing the business.

A partnership can bring in more capital investment and partners can also offset losses against other income.

The procedures and costs of formation and winding up are minimal, compared to a company.

Disadvantages
Each partner is liable for all of the partnership’s debts. Without appropriate asset management, this may put their personal assets at risk.

Summary

Choosing a particular structure impacts your potential liabilities and how you operate, grow or sell your business. Accordingly, it is worth investing the time and resources (including investing in the right legal, tax and insurance advice) into assessing what structure will best suit you and your business.

It is also important to keep in mind that, as your business changes, you may wish to shift between structures. You may start out in business as a sole trader and then later form a partnership with someone, or, as your business grows, decide to incorporate a company. Always bear in mind that your obligations and the risks under each structure will change with each entity.

NEED MORE INFORMATION?

If you have any questions or would like further assistance with choosing or setting up an entity, or with protecting your assets, please contact Alysha Hinton on (04) 471 9452 or at alysha.hinton@duncancotterill.com, or your local Duncan Cotterill advisor (duncancotterill.com).

 

Duncan Cotterill is a full-service law firm with offices in Auckland, Wellington, Nelson and Christchurch. Its dedicated construction and projects team can help make your business a success by working with you to put the deal together.

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.