Mind your own business

An introduction to business structures.

Just a short while ago a client came in to see me to discuss the breakdown in her relationship with her business partner. She told me that she wanted to discuss winding up the partnership under which she operated.

After some questions and searches it turned out that her business was not actually a partnership at all. My client had been in business using a proprietary limited company registered under the Corporations Act for years, but because she and her business ‘partner’ were equal shareholders in the business and had always referred to each other as partners, she had just assumed it was a partnership.

I have also had many clients over the years talk about ‘their business’ and control the finances of their business as though it were their personal bank account, when in fact the business was owned by the corporate trustee of the family trust or was a company with multiple family member shareholders.

Most businesses take one of three basic forms[1]:

1. Sole Trader
2. Partnership
3. Company

Even when businesses are operated through a trust structure the owner of the business will be the trustee of the trust – which is generally either going to be individuals or companies.

What is the difference between the different forms of a business:

A sole trader is generally the smallest and least formal of the business structures. It typically is a person who runs their own business – generally involving the sale of their own goods or services. Some typical examples would be Joe Jones – Plumber, or Mike Matthews – Bricklayer.

Normally this type of structure is easy to set up and has limited costs and reporting obligations. You do not need separate bank accounts or business registration if trading under your own name. However, the sole trader is personally liable for all liabilities of the business and cannot generally income split.

A partnership is a business carried on in common by 2 or more people with a view to profit. It is also a relatively simple business structure but does require separate tax file numbers and ABN. The partnership will file its own return, but taxes are paid by the partners on the profits or losses distributed to the partners.

There are different types of partnerships and they are typically established and governed by a partnership agreement – however a formal document is not required for a partnership to be created. That said, if you are considering a partnership structure – a formal partnership agreement is strongly recommended.

Finally, many businesses are operated under a company structure. The most common of these is a proprietary limited company – which is why you see Pty Ltd at the end of so many company names.

The most critical thing to note about a company is that the company is an entirely separate person to its shareholders and directors. That is – even if you are the sole director and shareholder of a company, you are not the company. You are Jack Smith, and the company is an entirely different person named Jack Smith Pty Ltd (ACN 100 254 286).

Companies are run by their board of directors, who have duties to ensure that the company is run properly, does not trade whilst insolvent, and is conducted for the benefit of the company as a whole. Directors have duties to the company – but they are not the company. Shareholders have a stake in the company, but they are not the company.

If you choose to use a company as a business structure, you will have to register the company and be given an Australian Company Number (ACN). Directors will need to understand their duties including the avoidance of conflicts. Directors also need to register and obtain a director ID number.

The assets of the company belong to the company, not to the directors or shareholders, and should be separately banked and accounted for. Companies also have additional reporting and registration requirements – but incorporation brings with it the advantage of limited liability – which offers some protection to directors and shareholders arising out of the separate legal personality of the company.

It would be easy to say that the benefits of incorporation mean that all businesses should consider setting up as companies – but the additional burdens that come with that are not suitable for all businesses. However, if you expect to grow, and you want the benefit of some protection of your personal assets, incorporation is going to be worth considering.

Whatever your business structure, CS Legal is here to help you with practical and relatable assistance and advice.

[1] Technically there are other business structures including Incorporated and Unincorporated Associations, and Joint Ventures, but those go beyond the scope of this article