Following the Canterbury earthquakes in 2010 and 2011, many small businesses have grown exponentially in a very short period of time. Such rapid growth can lead to increased exposure to risk and liability as well as administrative problems if the business structure is not the most appropriate.
Below are some examples of common business structures.
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 partnership or company.
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. If the business fails, the individual could lose personal assets such as savings and the family home.
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, which reduces personal risk. Each partner will be jointly and severally liable for the debts of the partnership. 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. A partnership dissolves each time a partner leaves the partnership or a new partner joins the partnership and it reforms again following that change.
A 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 can protect shareholders' personal belongings in the event that the business fails. The other major advantage of a company is that it makes raising capital 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 on-going administrative costs associated with operating a company, including filing an annual return, preparing financial statements and operating a bank account.
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.
A limited partnership is a separate legal entity (like a company). A limited partnership will be registered upon receipt by the Registrar of a properly completed application for registration. A limited partnership is governed by the Limited Partnerships Act 2008 and its written partnership agreement (which is compulsory).
A limited partnership must have at least one general partner and at least one limited partner. A person may not be both a general partner and a limited partner. A general partner is responsible for the management of the limited partnership. A limited partner must not take part in the management of the limited partnership. General partners and limited partners may, but do not have to, contribute to the capital of the limited partnership.
A general partner is liable for the unpaid debts and liabilities of the limited partnership. However, a general partner will only be required to pay such debts and liabilities to the extent the limited partnership is unable to pay. A limited partner who does not take part in the management of the limited partnership is not liable for debts and liabilities of the limited partnership.
A limited partnership 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 the debts and costs of 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.
Do you have the right business structure?
As noted above, it is common for a business to change structure as the business grows or changes its focus. It is important to ensure that your business structure works for you. In particular, 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?
- Does my business have appropriately skilled management and staff?
- Have I put in place appropriate governance documents for the current business?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.