What is a small business entity?
If you’re interested in stepping away from your 9-5 job to become a business owner you have to understand what you are getting yourself into. For me, it all begins with knowing what small business entity structures are available to you. As of 1 July 2016, you are a small business entity if you are a sole trader, partner, company, or trust which has an aggregated turnover of less than $10 million.
Today l will focus on an in-depth analysis of partnership vs company structure to elicit key elements that you need to be aware of as an aspiring business person. As the saying goes, “knowledge is power” and on that note here is what you’ll expect in this article.
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What is a Partnership?
A partnership is effectively a legally binding agreement usually between two or more individuals to carry out a common trade. Therefore, it requires a minimum of 2 participants. The law restricts this membership to 20 participants. A greater number is permitted for professional partnerships such as accountants and lawyers.
By law, a partnership is not a separate legal entity, unlike a company. The partners all have joint and several liabilities for actions undertaken by the partnership. A partnership is “the relationship that exists between persons carrying on business in common with a view to profit”. Terms of the partnership are set out in a partnership agreement, or deed, or maybe agreed verbally.
Types of Partnership
They are 3 main types of Partnership
- General Partnerships (GP) – is where all partners are equally responsible for the management of the business. Each member has unlimited liability for the debts and obligations it may incur.
- Limited Partnership (LP) – is made up of general partners and their liability is limited to the amount of money they have contributed to the partnership. Limited partners are usually passive investors who don’t play any role in the day-to-day management of the business.
- Incorporated Limited Partnership (ILP) – is where partners can have limited liability for the debts of the business. However under an ILP there must be at least one general partner with unlimited liability. If the business cannot meet its obligations, the general partner (or partners) become personally liable for the shortfall – as detailed in business.gov.au site.
Key positive elements to consider:
- Partnerships are relatively easy to establish. Partners can agree to create the partnership verbally or formal writing. There is no need to register with a government body like ASIC. It is advisable that partners put in place a partnership agreement document. This will document how the partnership will work, the rights and responsibilities of partners and what would happen in different situations, including if the partners disagree or they wish to leave or retire.
- Have minimal reporting requirements – the accounting process is simpler compared to companies. The partnership business is not required to complete an annual corporate tax return, however it is still required to maintain records of income and expenses.
- Greater access to capital – The more partners there are, the more financial resources there may be available to invest into the business. In addition, working together as a partnership enables you and your partner to have a greater borrowing capacity.
- Share control and management of the business – In a business partnership, the partners both own and control the business. All they need to do is agree on how to operate and drive the partnership forward, and can do so without the interference from any shareholders as is the case with a limited company. This can make a partnership business more flexible compared to limited company, with the ability to adapt more quickly to changing circumstances.
- Privacy – Compared to a limited company, the affairs of partnership business can be kept private by the partners. Additionally, allows you to enjoy limited external regulation as compared to a company structures.
Key setbacks to consider
- Joint legal liability
A major setback of this structure is that the liability of the partners for the debts of the business is unlimited. Unlike companies, partnerships do not have a separate legal identity. This implies that the partners are liable for the debts of the partnership. Joint liability means that each partner is equally responsible with the other partners for the obligations of the business.
- Tax implications
Furthermore, a partnership is not a taxable entity. Thus, it does not pay tax on its income but instead passes it on to the partners. Those in their individual capacities account for it in their own individual income tax returns regardless of whether their share has been actually distributed.
- Initial funding
Partnerships rely on the personal funds of the partners as well as borrowings to meet their capital requirements. This means that partners may find themselves in a state of financial deficit if they fail to meet their funding requirements.
- Partnership termination costs
In the event of termination of the partnership where one partner wishes to leave. All partnership assets must be valued and this process is costly.
What is a Proprietary Company?
In contrast to a partnership, a proprietary company has a separate legal identity. This makes it responsible for its own debts. It has the legal capacity of an individual person. A company has the ability to buy assets, enter contracts, and sue and be sued. Applicable after its creation which involves a stipulated registration process. Furthermore, this characteristic of being an individual means that companies can offer limited liability that can be enjoyed by its members and property.
A separate legal personality gives the company several distinguishing traits. Firstly, it means that the company is separate from all parties, including its directors and members. Secondly, detachment from other parties gives the company what is commonly known as the “corporate veil.” This means that the debts, obligations, and actions of the company are its own responsibility and not that of its participants.
Types of Companies
They are 2 main types of company structures.
- Proprietary Company – Have a maximum of 50 members.
- Public Company – May have an infinite number of members.
Key positive elements to consider
- Separate legal entity
The advantages of forming a company structure are that it offers the safest form of business for a member. The risk of loss is transferred to the company’s creditors. These include the banks and financial institutions that lend money to the company.
- Easy transfer of ownership
- Taxation rates can be more favourable with a flat company tax rate which is usually lower as compared to the marginal tax rate applied to partnership structures.
- Wider access to capital.
- Company members have limited liability
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- Expensive to establish and has higher running costs.
The disadvantages of companies are that they can be relatively expensive to establish, maintain and wind up.
There is relatively greater regulation of companies under the Corporations Act 2001 (cth) as compared to that of partnerships that enjoy less regulation. You should understand and comply with the obligations under this act.
- It’s more complex business structure to start and run.
- It requires annual tax returns to be lodge with the ATO.
There is a lot that you need to consider if you are deciding whether you need to set up your business as a partnership or limited company. Both entity types have their own merits and demerits. I guess it is vital that you do comprehensive research as well as seek professional advice to make sure that you make an informed decision. After all, you will be investing your time, money, reputation, and career in your business venture, therefore it is worth the extra effort that is required to fully understand what entity type best suits your situation.