How to choose the best business entity for your startup – Your Accountants Plus Roadmap
Starting your own business is a huge accomplishment. You have the power to be your own boss, set your own hours, and make your own decisions. But with this power comes great responsibility – namely, the responsibility to choose the correct business entity. Business structures can be complex, and there are a few different structures to choose from, each having its own set of advantages and disadvantages. Therefore, having a clear understanding of the taxation impact based on your business decisions is crucial to your business success.
While diverse ways of structuring your business have different legal and financial implications, there are a few options to get started. This article will guide you through the process of deciding whether a Sole Proprietorship, a General Partnership, a Limited Liability Partnership, or a Limited Liability Company will work best for your business.
A Sole Proprietorship is the simplest business structure as it does not require forming a company, a corporation, or any other kind of business structure. The owner as the single legal entity is responsible for all areas of operation including business management and income- and expenses management and all risks and liabilities of the individual are carried by the Sole Proprietor himself/herself. Sole Traders can also decide how much risk they want to take on, choosing whether to limit their liability for certain types of operations like construction work or choosing to be contracted out professionally.
Despite not being a company, Sole Proprietorship permits entrepreneurs the ability to offer services and products under a trading name along with a physical location and a business website, allowing to raise invoices, claim expenses, depreciate assets and recruit staff. A GST registration and correlated payments for Sole Traders become mandatory if their total turnover has exceeded $60,000 in the year they have been in business. However, the $60,000 threshold is only applied to the Sole Trader’s total self-employment earnings, and freelancing and contracting income, meaning wages and salary income are not taken into account.
The major advantage of a Sole Proprietorship is complete control over the business. You can make all the decisions, and you do not have to answer to any partners or shareholders. However, this also means that – in the event of an incurred business-related litigation – as a Sole Proprietor you are at risk of having all your personal assets at stake. Another disadvantage is the potential difficulty in raising capital. Since you are the only owner, potential investors may be reluctant to invest in your business. And, if you do manage to secure funding, you will likely have to give up a significant portion of ownership in the company.
General Partnership & Limited Liability Partnership
When launching a small business with a friend or partner, the excitement of starting something together can be overwhelming. But while having a partner can be a terrific way to reduce individual business risk, it is important to understand and set up the business structure correctly to protect both partners’ financial futures.
Partnerships are a generic form of enterprise in which two or more people share the profits and losses of a business, with successful partnerships having a mutual goal to which both partners contribute equally. These partnerships are of two types, General Partnerships (GP) and Limited Liability Partnerships (LLP), whereas the income tax rate differs between the two options.
A General Partnership is the simplest business structure, in which all partners are jointly and severally liable for the company’s debts and obligations. This means that if the business goes bankrupt, each partner is on the hook for the entire debt – no matter how much everyone contributed to the business. This type of partnership is generally not advised for small businesses, as the personal liability of each partner can be financially crippling.
A Limited Liability Partnership, on the other hand, is a specific form of partnership where one partner is called the general partner, and the other is called the limited partner. General partners have unlimited liability for the debts and obligations of the company, while limited partners only carry liability in proportion to their capital contribution. The limited partner’s role is typically restricted to financial contributions and by forming a Limited Liability Partnership partners are shielded from personal liability for the company’s debts, as long as they are not actively involved in managing the company. The general partners, contrary to limited partners, are responsible for managing the business, and are liable for its debts.
Both entities must be registered with the New Zealand Companies Office, and as with Sole Traders, a GST registration must be completed if the turnover is more or expected to be more than $60,000 within the year business activities have been commenced. Furthermore, a partnership agreement must exist for both types of partnership, outlining the terms and conditions of the partnership. This agreement is required to be in compliance with the Limited Partnership Act 2008 and should include, for instance, how and when a termination of the partnership would come into effect, as well as information about restrictions on the ability of a partner and/or on the business or other activities, indicating the nature of those restrictions. The agreement should also include provisions that explain the division of profits and losses, the capital contribution of each partner, and the rights and obligations of the partners regarding the management of the partnership.
In conclusion, in a General Partnership, the general partners are not only held liable for the debts and liabilities of the enterprise, but equally for the debts incurred by the actions of their fellow partners, while limited partners have a separate legal personality from their general partners. Comparing a General Partnership’s ability with the ability of a Limited Liability Partnership to raise capital and attract investors, a General Partnership is limited by its potential personal liability.
Limited Liability Company
The Limited Liability Company (LLC) is a hybrid of a partnership and corporation, and it is the most popular entity type for small businesses in New Zealand today due to the limited, personal risk incurred when running a business, which leads to an increased business activity and encouraged economic growth. A type of entity that can be adapted to suit the needs of various industries, meaning that the LLC can enter contracts, own property, and sue or be sued.
Establishing an LLC necessitates the appointment of a legal representative to grant power of attorney – allowing your representative to act on behalf of the LLC in all legal aspects – and the engagement of at least one shareholder, and at least one director (with no maximum number of shareholders and directors, and no minimum required share capital).
Run by a management team of directors made up of one or more people who are appointed by the shareholders, this team runs the day-to-day business of the LLC, a separate legal entity from its shareholders. Its shareholders are the company’s owners, having contributed capital to the business. However, the company is liable for its own liabilities, and the shareholders will not personally bear these liabilities, meaning personal assets of the business owner are protected from company liability.
While financial statements are required to be prepared and filed with the Companies Office on an annual basis, regular meetings of shareholders and directors must be held, and minutes of these meetings must be kept. Nevertheless, a GST registration is optional for LLC’s generating less than $60,000 per annum. However, where business turnover is expected to be more than $60,000 per annum, a GST registration will be inevitable. Furthermore, it is advisable to draft a constitution, setting out the rules of operating and managing the LLC, and describing the rights and duties of the shareholders, the management team, and the company itself.
In conclusion, a Limited Liability Company is a great option for those who want limited liability protection, more flexibility in managing their company and for those for whom growth is a key factor.
Which entity you choose as a business owner will depend on a number of factors, including the amount of liability protection you need, the size and complexity of your business, and your tax situation.
Get advice from experts on solutions that take the complexity out of company formations, Accountants Plus, we offer impartial business advice and guidance. Let us help you succeed by getting in touch with us, focus on what’s important – your business.