Business Structures

Published in Business Law, Tim Brown

One of the most important things for business owners to consider is whether they have the right business structure and whether that business structure needs to change as the business grows and evolves. Many new businesses experience rapid growth and development, which can increase exposure to risk and liability and cause administrative problems if the business structure is not suitable. Below are some examples of common business structures.

Company

The most common type of business structure is a company. A limited liability company is a distinct legal entity, separate from its shareholders (owners) and directors (managers). The concept of “limited liability” is perhaps the most attractive aspect of choosing a company as your business structure. The company owns its assets and liabilities, so any debts or liabilities to shareholders are limited to their investment in the company (unless a shareholder has signed a personal guarantee in relation to the company). This helps to protect shareholders’ personal belongings in the event that the business fails. The other major advantage of a company is that it makes raising funds much easier. This can be done either through issuing new shares to new or existing shareholders or through borrowing money secured against the assets or future revenue of the company.

Companies are easy to set up. This can be done online through the Companies Office website for a small incorporation fee. A company must have a company name, at least one share, at least one shareholder and at least one director. There are minimal on-going administrative costs associated with operating a company, such as filing an annual return and preparing financial statements.

Companies are governed by the Companies Act 1993 as well as by various other pieces of legislation. Many companies also have a constitution, which is a governance document that varies and supplements the Companies Act 1993. Some companies also have a shareholder agreement which sets out the rights and obligations of the shareholders of the company.

Sole Trader

A sole trader is essentially an individual trading personally. This is suitable for small businesses, such as a corner dairy, a hairdresser, or a tradesman with few staff. Many businesses begin as a sole trader before growing into a company or some other structure. The advantages of a sole trader are that there are low costs and little administration, the individual has complete control of his or her business, and he or she gets to keep all of the profits of the business. However, all of the expenses, debts and liabilities of the business are personal to the individual and there is no limitation of liability meaning that if the business fails, the individual could lose personal assets such as savings and the family home.

Partnership

Partnerships are becoming less common these days but may still be useful in certain situations. A partnership is similar to a sole trader but with two or more joint owners called partners. The partners share the profits of the business but they also share the expenses, debts and liabilities of the business. In saying that, each partner will be jointly and severally liable for the debts of the partnership and their personal assets may still be at risk if the business fails.

Partnerships are easy to set up (no registration is required) and flexible as to how they operate. Partnerships will be governed by a partnership agreement or deed (this gives the partners the flexibility to manage their business how they want to) as well as the Partnership Act 1908.

Limited Partnership

A limited partnership (LP) is a separate legal entity (like a company). A LP is governed by the Limited Partnerships Act 2008 and its written partnership agreement (which is compulsory). A LP must have at least one general partner (responsible for the management of the LP) and at least one limited partner (which must not take part in the management of the LP). A person may not be both a general partner and a limited partner. General partners and limited partners may, but do not have to, contribute to the capital of the LP. A general partner is liable for the unpaid debts and liabilities of the LP, to the extent that the LP is unable to pay. A limited partner who does not take part in the management of the LP is not liable for debts and liabilities of the LP. A LP has certain tax advantages that other structures do not benefit from. It is a vehicle which is often used by offshore investors in New Zealand.

Incorporated Joint Venture

A joint venture is a popular business structure for two or more parties to engage in a specific project or projects. A joint venture can be incorporated as a company with a 50/50 shareholding, for example. It is very important to have a shareholder agreement (or joint venture agreement) including robust dispute resolution procedures to deal with deadlock situations.

Unincorporated Joint Venture

Alternatively, a joint venture can be unincorporated, meaning it is solely contractual in nature. This allows the joint venture the flexibility to operate in the way that the parties choose, according to the contract they enter into creating the joint venture. The joint venture parties cannot bind each other and they are not jointly liable, meaning that each of the joint venture parties will be responsible for its own debts and costs relating to the joint venture (similar to a sole trader). Careful drafting is necessary to ensure that the joint venture is not deemed to be a partnership, where each party is liable for the debts of the partnership. An unincorporated joint venture can be less marketable and harder to obtain finance.

Incorporated Society

An incorporated society is a popular structure for members pursuing shared cultural, sporting, recreational, community, religious or educational interests. The key from other business structures is that it must not distribute profits or financial benefits directly to its members. An incorporated society is allowed to run a business, provide benefits to members and the public and reimburse members for reasonable expenses, but the members should not have an ownership interest in the society or its assets. Incorporated societies are currently governed by the Incorporated Societies Act 1908 (Act) and the society’s rules (or constitution). The Act provides a broad framework, allowing each society the flexibility, through its rules, to operate in furtherance of its particular structure, culture and goals.

Do you have the right business structure?

Regardless of the industry in which your business operates, it is important that your business structure works for you. You may wish to ask yourself these questions:

  • Are my personal belongings protected if my business fails or is sued?
  • Does my business have access to adequate levels of finance?
  • Have I put in place appropriate governance documents for the current business?

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

Tim Brown has specialised in business/commercial law for over 13 years. Tim is an expert in all business law matters, including establishing new businesses, buying and selling existing businesses, restructuring and succession planning, commercial contracts, capital and debt funding, corporate governance and compliance.

For further information on business structures, please contact Tim.



Tim Brown (LLB, BCom)
Director / Solicitor

First Floor Conway Building
188 High Street
PO Box 576
Rangiora 7400

tim@conwaylaw.co.nz
www.conwaylaw.co.nz