In this article Andrew Comer, Principal at law firm Stace Hammond, explores the three most common business structures typically adopted by start-ups and outlines some factors to consider when deciding which one to adopt.
There are many ways in which a business can be structured. The three most common structures adopted by business owners tend to be a sole proprietorship, a partnership and a limited liability company.
The decision as to which structure a business owner should adopt will be guided by many things, including: the industry in which the business operates; the number of owners and the extent of their involvement in the business; the tax implications of choosing one structure over another; the size of the business itself; and the business owner’s appetite for liability.
A business’s structure will have an impact on such things as the business’s capacity to expand, secure loans, attract investment and the business’s appeal to prospective buyers, should the business owner wish to sell.
Each structure also has its own unique set of advantages and downsides. A quick overview of these considerations is set out below:
A sole proprietorship is where a business is carried on by an individual, either in the individual’s name or under a business name.
A sole proprietorship is, in relative terms, the most simple structure to adopt – all that is typically required, in order to commence business, is for the sole proprietor to register with IRD (for GST where historic or expected annual turnover is greater than $60,000 or if the sole proprietor intends to hire employees) and comply with any industry-specific requirements (i.e. hold any necessary qualification, licence, permit etc).
There are no registration or legal fees associated with setting up a sole proprietorship.
A sole proprietor has complete control over the business and retains all of the business’s profits.
The business is taxed at the sole proprietor’s individual tax rate.
A sole proprietor has no separate legal status from the business – that is, they are treated as one and the same – and is, therefore, responsible for all of the business’s debts and liabilities. This exposes the sole proprietor’s personal assets to risk.
Sole proprietorships do not typically have the same appeal to financiers or investors as do other business structures. As a consequence, business growth can be slower for sole proprietorships.
A partnership is where two or more people, or entities, carry on (and share the profits and liabilities of) a business. It is a relatively common structure adopted by businesses in professional service industries (e.g. law, architecture and accounting). A partnership may exist between parties, irrespective of whether this was the intended outcome or not or whether the parties have entered into a formal partnership agreement.
A partnership is a relatively simple structure to adopt and registration requirements mirror those of sole proprietorships.
Like a sole proprietorship, each partner’s income is taxed at the partner’s individual tax rate.
Partners can bring capital and specialised services to the table.
Partners have ‘joint and several’ liability for the partnership’s debts – this means a partner will be responsible for all of the partnership’s debts (including those debts incurred by fellow partners).
A partnership is not a separate legal entity from the partners and so, much like a sole proprietorship, a partner’s personal assets are at risk and may be used to satisfy the partnership’s debts.
Partners will be bound by, and must observe, the provisions of the Partnerships Act 1908, the common law and (if partners have entered into one) a partnership agreement.
*Note: The concept of partnership referred to above is distinct from a ‘limited partnership’, a structure governed by the Limited Partnerships Act 2008, which will be discussed in a subsequent article.
Limited Liability Company:
A limited liability company is a separate legal entity from those persons who own and control the business (i.e. its shareholders and directors) and is the most widely accepted and understood of all business structures.
As a general rule, the liability of shareholders is limited to the fully paid-up value of their shares – that is, creditors cannot recover company debts from shareholders beyond what they owe in respect of their shares. (One exception to this rule, however, is where a shareholder has given a personal guarantee in respect of the company’s financing and security, leasing and trading arrangements etc.)
A company will survive the death of its shareholders, continuing indefinitely, until it is removed from the Register of Companies.
In most cases, a company which operates at a loss (i.e. where its expenses are greater than its income) do not have to pay income tax.
There are prescribed formalities and costs associated with the incorporation of a company.
A company must comply with a number of ongoing regulatory and administrative obligations, most notably under the Companies Act 1993 and (if it has adopted one) the company’s constitution.
Company directors must comply with directors’ duties which are set out in the Companies Act 1993 and they will be personally liable for any breach of those duties.
Most company financiers will require the company’s directors to provide security in the form of personal guarantees.
The above overview has kindly been provided by Andrew Comer, a Principal at law firm Stace Hammond. It has been provided for general information purposes only. It is not, nor is it intended to be treated as, legal advice and is subject to change without notice. It is not intended to be an exhaustive list of all possible business structures. Other common business structures will be explored in a subsequent article.
Andrew specialises in corporate and commercial law and regularly provides advice in relation to start-up companies, mergers and acquisitions, joint ventures, capital raising, commercial contracts, corporate governance and company secretarial matters.
Stace Hammond is a New Zealand law firm with offices in Auckland, Hamilton and Tauranga with legal expertise in the areas of business, finance, corporate and dispute resolution.