Introduction to company law
Emma Roberts • 13 February 2022

Part 1: Choosing the right business structure


If you are thinking about starting a new business, one important consideration will be how that business is to be structured. This decision will depend on a number of considerations, including:


  • The amount of control and responsibility you wish to have over the business;
  • The amount of risk involved with the venture, and therefore how important the extent your personal liability may be;
  • Tax considerations and implications;
  • The ability to grow the business; and
  • Cost and ease of establishment and compliance of the business.


Generally you will need to choose a business structure that will give you the greatest security, flexibility and profit while minimising its tax costs.


The three main business structures used in New Zealand are:


  1. Sole trader;
  2. Partnership; and
  3. Companies.


Sole Trader


A sole trader is an individual who is in business either in his or her own name or under a business name. If you are a sole trader you and your business are considered to be the same legal entity. All income from the business is included in your personal income, and taxed at your individual tax rate.


The advantages of operating as a sole trader are:


  •  No registration is required, which can mean lower administration costs.
  • You have entire control the business.
  • The profits go directly to you.
  • Any tax losses made by the business can be carried forward indefinitely and offset against future income.


The disadvantages of operating as a sole trader are:


  •  You will have unlimited personal liability for all of the debts of the business, so your personal assets will be at risk.
  • It is difficult to grow the business, for example through outside investment.
  • It can be difficult to sell the business, and there may be tax liability on the sale.


A sole trader may be the appropriate business structure for a small first off business as it is relatively straight forward and low cost. But if the business is looking to grow, or you want to protect your personal assets, one of the other structures discussed below should be considered.


Partnership


A partnership is a group of people or entities operating in business together. As with a sole trader, no registration is required, and it is not a separate legal entity. Generally the partners formalise their arrangement through a partnership agreement, although this is not legally required.


All the partners are bound by any act carried out by one of the partners acting in the ordinary course of business. The structure is therefore suited to when there is a small number of partners who know and trust each other. The profit of the business is shared out to the partners and each partner taxed on his or her individual income.


If one of the partners leaves the partnership, the partnership is dissolved and the remaining partners will need to enter into a new partnership.


The advantages of operating through a partnership are:


  •  The responsibility, costs and decision making for business are shared between the partners.
  • Each partner may bring different strengths and skills to the business.
  • If the partnership makes a loss it can be offset against the partners’ other income.

The disadvantages of operating through a partnership are:

  • Each partner has unlimited liability, and so their personal assets will be at risk (although it is possible for some partners to achieve limited liability through the use of a limited partnership).
  • Each partner has joint and several liability – so one partner could end up paying not only their share of the business’s debts, but their partners’, if the other partners were unable to pay their share.
  • The partners may disagree on certain decisions which could lead to conflict.


Companies


A company is an incorporated entity that has been registered with the New Zealand Companies Office. Unlike a sole trader or a partnership, a company is viewed as a separate legal entity to its shareholders. It owns all the assets and liabilities, whereas a sole trader would own them directly.


A Company has limited liability and so is liable for any debts it owes, rather than the shareholders directly. If the company fails, then the shareholders only lose the value of their shares.


However, if you’re involved in the running of the business as a director, you can be held liable for debts if your conduct is deemed to have been reckless, fraudulent or not in the company’s best interests. Lenders will also often only lend you capital once you’ve signed a personal guarantee over-riding your limited liability status.


This limited liability protection and the transparency of the company registry system (which allows anyone to see who’s involved with a company as a shareholder or director) can give greater confidence in this type of business structure compared with others.


Companies are taxed at the company tax rate (currently 28%) while the profits received from companies by shareholders (usually as a dividend) are taxed as part of that shareholder’s individual income. This means tax will ultimately be paid on company profits at the shareholders’ tax rates, even though the company rate is 28%.


The advantages of a company are:


  • Easier to attract funding and investment.
  • More credibility in the marketplace.
  • Easier to sell the business because it’s a separate entity.
  • The business can grow and last indefinitely because it isn’t tied to one person.
  • Shareholders’ liability is usually limited to their share of ownership.
  • Tax rate is lower than the top personal rate and the trust rate.

The disadvantages of a company are:

  • Higher levels of regulation compared with sole trader and partnership structures.
  • Can require larger amounts of investment.
  • Directors need to carefully understand their responsibilities.
  • If losses are made, they are retained by the company so they can’t ordinarily be offset against the shareholders’ other income for tax purposes.


Summary


There is a lot to consider when you are venturing into the commercial world, and taking some time at the very start of the process to ensure your business is structured in a way that is most adventurous to your individual circumstances can save later issues arising. We would be happy to discuss with you the various options outlined above in greater detail.

Our next article will look at how to start a company.

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