Legal Structure for your Business

What is a Legal Business Structure?
A business structure is the form, or type of business entity, under which you choose to run your business. There are a number of structures you can choose and each one has advantages and disadvantages. The structure you finally select will depend on the type of business you run and also on the objectives, both financial and personal, incorporated in your business and personal goals.

For example, if you are looking at bringing in investors at a later date, or if you have plans to turn your business into a public company in the future, then these goals will affect the structure that will best suit your business.

The choice will also depend on the size and nature of your operation. Whether you are buying or setting up a new business, the legal considerations that may be involved will also affect the type of structure or “legal entity” you will adopt.

Most small businesses in New Zealand are operated as sole traders, partnerships, companies, trusts, or other less used structures such as cooperatives, etc.

You will need to put some thought into the type of structure to use because your decision may have far reaching implications later on. For example, if you decide later to sell the business, or perhaps take on a partner, it may be best to work this future objective into the type of structure used.

Why the Correct Structure is Critical
The choice of a business structure will have many implications.

Some of these include:

  • Personal responsibility for all the debts and liabilities of the business.
  • The taxation of profits of the business.
  • The cost of set-up and establishing the business at the beginning.
  • The cost of complying with any requirements of government regulations.
  • The ability to do business around New Zealand and overseas.
  • Whether you will be subcontracting out some of the work you will receive.
  • How you structure the business when you have other partners and investors.
  • The ability for the business to be closed and for investors in the business to recover the investment.
  • The need to distinguish the business products and services from its competitors.

Basics of Legal Entity – Main Entities Involved
Apart from the original decision to go into business, perhaps the other most important decision is which entity the business will be run under. When an entity has been selected, the legal implications will need to be considered.

Some structures have very little legal requirement (as far as compliance is concerned) while others have to follow regulations and be accountable to government departments.

The decision you make will be based on factors such as the number of owners in your business, the desire to limit your exposure to liabilities of the business and the need for tax savings.

There are 3 main entities involved:

  1. Sole Proprietorship.
    This is the simplest form of business entity. Here, one or two people own the business and operate as a sole proprietorship. No licenses or no legal involvement is required, except with the IRD for taxation and GST. The income of the business is taken as income belonging to the proprietor and the proprietor pays the tax. It is generally easy to start this type of entity, but there is no protection from creditors of business debts should things go wrong in the business.

  2. Partnership.
    Here there are 2 or more people who join together to own and run a business. Each partner assumes full responsibility for all the debts of the business. The partners share the profits as well as the losses. They share the assets as well as the liabilities. The taxation is similar to sole proprietorship. The profit is divided amongst the partners who each pay personal taxation on the income. The partnership itself is not taxed. The exposure to liability is unlimited, as in the sole proprietorship, so if things go wrong creditors and others with claims against the business can sue the partners individually, or together, to recover any losses incurred.

  3. Limited Liability Company.
    The limited liability entity was created to give protection from liability to owners of a business. A limited liability company is a separate legal entity, or legal person, in the eyes of the law. The owners or shareholders in the company are merely holding an interest in the business. They are not the business. The benefit of a limited liability company is that the shareholders in the business do not have to pay any more than they owe on their unpaid shares (if they are unpaid) in the event of the company failing. This is probably the most common entity used if a business owner is serious about separating the family assets from the business. If the company fails, because it is a separate person it cannot call on the assets owned by the owners or their families.