Welcome to Business Structures. In this topic, you will learn about:
- The essential characteristics of sole traders, partnerships, joint ventures, associations, companies, and trusts
- The legal obligations imposed on each type of business entity
- The liability of the parties involved in each type of business entity
- The advantages and disadvantages of each form of business operation
- Business name registration.
There are a number of business structures that can be chosen to operate a business. A business may appoint an agent to do business on their behalf. Agency is a relationship where one person (principal) appoints another (the agent) to enter into a contract on their behalf with a third party. The resulting contract is between the principal and the third party. An agent owes a range of duties to their principal, which you will explore in this topic.
An individual may operate a business as a sole trader. This is the simplest and least formal structure to establish and is very well suited to one-person businesses. If two or more people wish to operate a business, they have the option of creating a partnership. Specific legislation governs the operation of a partnership and this protects partners. Both sole traders and partners have unlimited liability for business debts and this is a significant disadvantage. Another option a business has is to establish a trust to operate its business. It may also be necessary to register a business name in certain circumstances.
Often a business decides to incorporate as a company to operate a business. This has many advantages, including the fact that the company is a separate legal entity. A company is liable for debts not individual members or company officers. The company can contract in its own name and own property in its own name. However, there are many more formalities to comply with and the cost of establishing a company is not insignificant.
Before you begin, take a look at the two links below:
The Australian Securities and Investment Commission lists the steps required to incorporate a company in Australia. Take note of each step and the documentation that is required. You will see that it is a lot more work and expense to register a company than it is to establish business as sole trader or partnership.
The Australian Government provides a business structures resource which will give you an insight into the features of each type of business structure and the reasons why a business may choose one structure over another. This is a very good resource and you should spend some time exploring the information on this site. Make sure that you click on the hyper-links that contain more detailed information on each type of business structure. It explains the main features of the following business structures; sole trader, partnership and a company.
There are various ways that a business can be carried on, with each business structure having advantages and disadvantages that need to be considered. The following table provides definitions of each structure.
| Term | Definition |
|---|---|
| Sole trader | Business is owned and operated by one person with all profits or losses attributed to the owner. |
| Partnership | Relationship between two to 20 persons who carry on business in common with a view to profit. |
| Joint venture | Usually a one-off enterprise, with participants receiving profits separately, based on contractual agreement. |
| Unincorporated association | Body of two or more persons, organised for a particular purpose, which may or may not include the purpose of carrying on business with a view to a profit. |
| Incorporated association | Body of two or more persons, organised for a particular purpose, which may not include the purpose of carrying on a business with a view to a profit. |
| Company | Incorporated body created by a process called 'incorporation', regarded by law as a separate legal entity. |
| Trust | Relationship recognised by the law of equity, where a trustee holds property for a beneficiary or beneficiaries. |
Please visit the ATO website and scroll down to watch a short video titled: 'Choosing your business structure'. This video provides a good summary of business structures open to Australian businesses and the features of each structure.
Each structure will have a unique formation. Read the following points for more information.
- Sole trader: simple; little documentation
- Partnership: partnership agreement advised; easy to form
- Joint venture: normally involves a one-off enterprise based on contractual agreement between two+ entities; relatively high establishment costs
- Unincorporated association: formed by persons with similar interests; no separate legal existence
- Incorporated association: unincorporated associations can incorporate, but not if they have a view to trading; relatively high establishment costs
- Company: relatively high establishment/compliance costs
- Trusts: relatively high establishment costs.
The type of control applied also varies. This will be evident from the following information.
- Sole trader: makes all the decisions
- Partnership: depends on partnership agreement. If no agreement, all partners are considered equal and each partner is considered as agent of the partnership and every other partner for the purposes of partnership business.
- Unincorporated association: control rests with committee of associates
- Company: power is vested in the board of directors to make decisions, unless power delegated to others
- Trusts: trustee has power vested in him/her to make decisions, subject to the terms of the trust deed and the trustee legislation.
How the structure are managed, the level of flexibility, the expertise required and taxation will vary between the structures. Read through the following table and note the differences.
| Management | Flexibility | Expertise | Taxation | |
|---|---|---|---|---|
| Sole trader | In hands of individual; absences from business difficult | Nature of business can be altered | Limited to one person’s knowledge, unless additional personnel are hired. | Dependent on level of profits. Large profits mean high taxation, as income only attributable to one person. |
| Partnership | Leave other partner in charge when absences required | Nature of business can be altered with agreement of all partners | Several areas of expertise available from individual partners. | Profits of partnership are shared as agreed. Taxed in the hands of the partners. |
| Joint venture | Depends on terms of joint venture agreement | Depends on terms of joint venture agreement | Can draw on the skills of those involved in the joint venture. | Income received separately. |
| Association | In hands of committee of association | Not applicable | Can draw on the skills of the members. | Not applicable |
| Company | Undertaken by board of directors | Nature of business can be altered but may have tax consequences |
Can draw on the skills of all the directors. | Special company tax rates. Can be distributed to access tax advantages. |
| Trusts | Undertaken by trustee | Nature of business restricted by trust instrument | Relies on the skills of the trustee. |
Income taxed in hands of individual beneficiaries. Can be distributed to access tax advantages. (Discretionary trusts allow changing distributions of income and capital between beneficiaries in different years.) |
Trusts
There are five elements constituting a trust:
- Settlor: person responsible for creating trust
- Trustee: person to whom trust property is given
- Beneficiary: person to benefit from the trust
- Trust property: property that is the subject of the trust
- Trust instrument: document detailing terms of the trust.
Select the following headings to learn more about the diffent types of trusts and the rights and liabilities of trustees.
Intentional act of a settlor, created by words (written or spoken):
- Identifying the trust property
- Indicating nature and purpose of trust
- Identifying beneficiaries
- Can be discretionary, where trustee will choose the amount to be distributed to beneficiaries.
No intentional action by the settlor:
- Implied trusts (presumptive trusts): law draws inference from the circumstances that a trust was intended
- Resulting trusts: where property returns to the creator of the trust
- Constructive trusts: result from the operation of law (of equity).
- Private: for the benefit of private individuals
- Public: for the benefit of some public purpose
- Trading: the property of the trust is used in the running of a business
- Unit: the beneficiaries own units of the trust.
- Maintain fiduciary relationship
- Familiarise themselves with the trust property
- Obey instructions
- Not delegate duties
- Not derive profit from their position
- Keep proper accounts
- Maintain impartiality
- Exercise reasonable skill and care
- Pay and transfer property only to those entitled.
- Reimbursement for expenses incurred
- Indemnification against all costs
- Seek contribution for losses
- On completion of administration of trust, entitled to receive a discharge.
- Personally liable for tortious and contractual liabilities
- A court or the beneficiaries have the power to relieve a trustee from liability.
Before we discuss legal obligations we will recap on company types.
Types of companies
- companies limited by shares: shareholders are liable for unpaid amounts on their shares. These companies can be public or proprietary and, small or large (1-50 members)
- companies limited by guarantee
- unlimited liability companies
- no liability companies— for example, mining companies.
Incorporating a company
For a company to become a separate legal entity, it must go through a process called ‘incorporation’. Under the Corporations Act 2001, ‘to register a company, a person must lodge an application with ASIC’ and nominate:
- shareholder(s)
- director(s).
The Australian Government provides extensive information including fact sheets which focus on the particular industry a business may be engaged in, and considers the legal implications of operating in that industry. Explore this site and make sure you review the information relevant for the industry in which your business for Assessment 2 and 3 will operate. The information that you gather may assist you in the preparation of your assessments.
Take time to look at the information below regarding directors, their duties, personal liability and criminal offences for breaches.
- A director is a manager or ‘mind’ of a company.
- Depending on the size and the nature of the company, is simply appointed or elected by shareholders
- Natural person
- Over 18 years of age
- Power to manage company assets
- Upper age limit of 72 years for public companies.
- Act in good faith for the interests of the company
- Exercise powers for a proper purpose
- Use discretions properly
- Avoid a conflict of interest
- Act honestly
- Not to misuse company information
- Not to obtain a gain by using their position
- Use care and diligence.
Directors may face personal liability for:
- making false and misleading statements or omissions in prospectus
- failing to appoint a company secretary
- incurring debts when the company had little prospect of repaying the debts.
These include:
- recklessly or intentionally failing to act in good faith to protect the interests of the company
- dishonestly using the position of director within the company, either intentionally or recklessly, to gain an advantage
- dishonestly using company information, either intentionally or recklessly, to gain an advantage.
Rights of shareholders
Shareholders within a company are entitled to:
- notice of meetings
- attend meetings
- receive dividends
- financial information
- sue on behalf of the company.
Winding up a company
The winding up a company can be initiated by a director, a member or a liquidator of a company. Reasons for winding up a company can include:
- no longer carrying on a business
- failing to commence business within 1 year of incorporation
- outstanding debts of at least $2000
- members passing a special resolution to wind the company up
- membership falling below a certain number.
The following diagram illustrates the difference between limited and unlimited liability of the owners for business debts.
Liabilities for the different entities are briefly described in the following table.
| Entity | Description of liability |
|---|---|
| Sole trader | Unlimited liability. Personal assets available for business debts. |
| Partnership | Unlimited liability. Personal assets of partners available for business debts. |
| Joint venture | Unlimited liability for individuals who may be sued collectively or individually for the debts of the joint venture. No liability for actions of other participants. |
| Unincorporated associations | Limited to the amount of a member’s subscription. Liability for agents and breach of warranty of authority may fall on members of committee. |
| Incorporated | Limited to payment of outstanding fees of members. |
| Companies | Limited by shares or guarantees. |
| Trusts | Limited, if trustee is a company, to the assets of the company. If not a company, trustee personally liable for tortious and contractual liabilities. |
Every business structure will have advantages and disadvantages. Some of these limitations are presented in the following table.
| Business structure | Limitations |
|---|---|
| Sole trader | For life of the owner, without interruption. |
| Partnership | Death, bankruptcy, or withdrawal of a partner will end partnership. |
| Joint venture | Subject to the terms of the joint venture agreement; normally has a limited business life. |
| Association | Perpetual succession. |
| Company | Separate entity from owners; perpetual succession. |
| Trust | Terminates if trust property vests in person ultimately entitled to it. If trust property has been transferred to beneficiaries, continued administration of trust would be illegal. |
The below describes each business structure’s ability to raise capital.
| Business structure | Ability to raise capital |
|---|---|
| Sole trader | Limited to ability of one person to gain finance. |
| Partnership | Limited to ability of partners to individually gain finance. |
| Joint venture | Limited to the ability of the joint venture participants to gain finance. |
| Private company | Limited to ability of directors to gain finance. |
| Public company | Capital raised by way of either share capital by issue of prospectus or by debenture issue. |
Business name legislation
A business name must be registered unless all names of operators or traders are included in business name, that is the full names of the operators or the surname, plus:
- the first name or names
- the initial(s) of first name or names
- a combination of first name and initials
- the first name or names (or initials) by which individuals are commonly known.
In certain situations, businesses that operate as sole traders or partnerships may need to register a business name. The Australian Government provides information which describes when a business name will need to be registered, and the process for registering.
National Business Names Register
Previously, business names were registered on a state and territory basis. From April 2011, business names are registered nationally for between one and three years. The system is managed by the Australian Securities and Investments Commission (ASIC). Registration can be done online and a joint application can be made for a business name and Australian business number (ABN).
Business names previously registered in the states and territories will automatically be transferred to the National Business Names Register.
Purpose of registering business name
Registering a business name enables the public to know who they are dealing with as they can search a business name or ABN online at asic.gov.au. Registration also helps to protect the goodwill of the business.
There are a number of restrictions on registering a name:
- if it is identical to or closely resemble a name already registered
- if the name is undesirable
- if it is suggestive of connection with the government or banks
- if it may be likely to be confused with names of companies or incorporated associations
- terms such as ‘crown' or 'royal' must not be used.
End of topic forum
There are forum activities for this topic.
'Help me decide tool – which business structure?'- This activity allows you to explore what is the most suitable business structure for your business. You will need to work your way through a series of multiple-choice questions online.
Select the ‘Forum’ at the end of your module (which can be found within your navigation menu) and follow the instructions for each question pertaining to Topic 5 within the forum.
Who represents your business? Agency law in Australia (Part One)
Who represents your business? Agency law in Australia (Part Two)
These two (2) short articles introduce you to the concept of agency and how an agency relationship can be created and the limits that are placed on an agent’s authority. In the second article, the focus is on the duties an agent owes their principal. There is a discussion of a recent High Court case, Australian Competition and Consumer Commission v Flight Centre Travel [2016] HCA 49, that decided it was possible for an agent and a principal to be in competition with each other. This means that the behaviour of an agent can count as anti-competitive under competition law.
