types of business ownership

Choice of Ownership Structure

  • When starting a business, one must choose an ownership structure, which can affect operations and liabilities.

Common Ownership Structures

  1. Sole Trader

  2. Partnership

  3. Company

Sole Trader

  • Definition: A business owned by a single individual.

  • Examples: Delicatessens, plumbing services, freelance accounting.

Advantages:

  • Easy Establishment: Minimal legal requirements to set up.

  • 100% Profit: The owner retains all profits without sharing.

Disadvantages:

  • Unlimited Liability: Owner is personally liable for all business debts; personal assets can be seized.

  • Limited Capital: May struggle to raise sufficient funds alone.

  • Limited Advice: Fewer sources of guidance for decisions.

  • Risk of Closure: Business may cease if the owner falls ill.

  • No Sharing of Losses: Losses cannot be distributed among others.

  • Challenges in Taking Leaves: Difficulties in managing operations during absence without trustworthy helpers.

Partnership

  • Definition: A business owned by two or more persons (maximum 20 members).

Advantages:

  • Capital Raising: Greater ability to raise funds collectively.

  • Diverse Skills: Partners can bring varied skills and expertise.

  • Shared Workload: Work distributed among partners.

  • Coverage During Absences: One partner can manage in another's absence.

  • Shared Risks: Financial risks are split among partners.

Disadvantages:

  • Joint Liability: Partners are jointly liable for business debts.

  • Potential for Conflict: Disputes over decisions can arise and may dissolve the partnership.

  • Limited Lifespan: Partnerships can end with the death or retirement of a member unless otherwise agreed.

  • Profit Sharing: Profits must be divided, reducing individual gains.

Partnership Agreement

  • Importance: This written document outlines partnership features, including:

    • Objectives of partnership.

    • Profit/loss distribution ratio.

    • Voting processes and retirement procedures.

The Partnership Act 1895 (WA)

  • Governs partnerships in WA without a partnership agreement.

  • Partners work without an entitlement to a salary unless specified in an agreement.

Companies

  • Disadvantage of Sole Traders & Partnerships: Owners face unlimited liability; personal assets can be affected by business debts.

Corporations Act 2001

  • Regulates company formation and operation.

Definition of a Company

  • Legal Entity: Established as a separate legal entity; can enter contracts and own property.

  • Shares and Capital: Capital is divided into shares, with ownership lying with shareholders.

Example:

  • High Technology Proprietary Limited has:

    • 2,000 shares at $1 each.

    • Eric and Patricia each own 1,000 shares.

Company Limited by Shares

  • Definition: Shareholders' liability for company debts is limited to their shares' value.

  • Example: Jason purchases shares in a company and cannot be liable beyond his paid-up share amount (e.g., purchased 1,000 shares at $2 each).

Proprietary Companies

  • Definition: can’t raise public funds; must have 1-50 non-employee shareholders.

  • Must include "Proprietary" or "Pty" in the title.

Small vs. Large Proprietary Companies

  • Small Criteria: Must meet two of three conditions:

    1. Income < $25 million

    2. Assets < $12.5 million

    3. < 50 employees.

  • Reporting: Small companies don’t need financial statements unless requested by shareholders.

Advantages of Company Limited by Shares

  1. Perpetual Existence: Continues regardless of shareholder death.

  2. Limited Liability: Shareholders only risk their investment.

Disadvantages of Company Limited by Shares

  1. Regulation: Subject to strict regulations and governance.

  2. Costs: Generally more expensive to set up compared to sole traders or partnerships.

Comparison of Business Entities

  • Number of Owners:

    • Sole Trader: 1

    • Partnership: Up to 20

    • Proprietary Company: 1-50

  • Liability:

    • Sole Trader: Unlimited

    • Partnership: Jointly and severally liable

    • Proprietary Company: Limited to share value

  • Transfer of Ownership:

    • Sole Trader: Generally unrestricted

    • Partnership: Requires consent from all partners to transfer

    • Proprietary Company: Can include clauses to restrict share transfer

  • Ability to Raise Capital:

    • All face limitations; borrowing depends on assets and business performance.

  • Distribution of Profits:

    • Sole Trader keeps all profits.

    • Partnership shares based on agreement or law.

    • Proprietary company pays dividends approved by directors.

  • Accounting Entity:

    • Sole Trader: Separately identified from owner.

    • Partnership: Separately recognized.

    • Proprietary Company: Distinct legal and accounting entity.

  • Continuity of Existence:

    • Sole Trader: Ends with death or retirement.

    • Partnership: Ends without agreement upon partner departure.

    • Proprietary Company: Continues indefinitely regardless of ownership changes.

Sample Questions & Answers

  • Partnership Limit: 20 members

  • Debt Responsibility: Amanda pays partnership debts proportionately based on financial capability.

  • Partnership Advantage: Includes additional skills, capital pooling, but not limited liability.

Scenarios for Business Structure Choices

  • Situation A: Sole trader—home service, individual nature.

  • Situation B: Partnership—combining funds and expertise.

  • Situation C: Proprietary company—asset protection against creditors.

  • Situation D: Partnership—collaborative management with differing roles.

  • Situation E: Proprietary company—protect personal assets where there's potential risk.

Legal Structure Characteristics

  • Partnership vs. Proprietary Company:

    • Ownership: Partnerships have limited member count; proprietary companies allow for more complexity in ownership transition.

    • Continuity: Partnerships end upon events unless predefined, whereas proprietary companies endure past ownership changes.