Whenever people start a business, they need to determine which structure to use. The commonly used structures are partnerships, companies and sole traders.
A sole trader is generally the simplest option whereby a person trades under their own name. However, there are major disadvantages, as a sole trader is legally responsible for all aspects of a business. Any assets owned by the individual sole trader are at risk if there are any issues or claims made against the business, as the sole trader is the owner of the business.
This is often the most common way that small businesses start out; however, other structures can be much more advantageous in terms of limiting liability and protection of personal assets.
A partnership is an association between two or more people who wish to carry on a business in common with a view to generating a profit.
The main disadvantage of partnerships is the fact that partners can be liable for the debts of the partnership, which is the case for typical partnerships. Therefore, personal assets can be at risk.
Other forms of partnership include limited partnerships and incorporated limited partnerships.
A limited partnership has general partners and limited partners. General partners manage the business, while limited partners do not play an active role. Limited partners’ liability is limited to their monetary contribution whereas general partners liability is unlimited. Therefore, there is significant potential risk for general partners in terms of their personal assets and risk for limited partners where they cannot cover a potential liability up to their monetary contribution.
An incorporated limited partnership can include four types of partnerships, which are structures used for venture capital purposes. These include a Venture Capital Limited Partnership, an Early Stage Venture Capital Partnership, and Australian Venture Capital Fund of Funds and a Venture Capital Management Partnership.
It is always important to have a Partnership Agreement to set out the type of partnership (e.g. normal partnership or limited partnership), the partners’ details, their responsibilities, rights and obligations, monetary contribution to the business and how profits and losses of the partnership are divided.
A company is a separate legal entity that can trade on behalf of a business, enter into contracts with third parties, employ employees, owns all assets and is responsible for the liabilities of the business.
An owner of a company is a shareholder and is usually appointed as a director of the company where that shareholder owns a substantial amount of shares in the business.
The main advantage is the fact a company has limited liability, and its shareholders are not liable for its contracts and torts, apart from amounts unpaid on their shares. Individual directors will not be personally liable (unless there are some exceptional circumstances such as a breach of directors duties).
It is always important to have a Shareholders Agreement to set out the rights and obligations of the shareholders of the company.
Although a lot of small businesses tend to start a business with a sole trader structure, it is usually advisable to incorporate a company from the outset, which will own the assets of the business. This provides the owner (or shareholder of the company) with some protection from potential liability in respect of their personal assets. It also allows room to grow if capital is required from outside equity investors who may invest in the company for a proportion of the shares in the company.
LegalVision has lawyers that specialise in business structures and can advise you as to which structures might be more appropriate for your start-up business, as well as draft the relevant partnership agreements or shareholders’ agreement (for companies).