Common business structures
Whether you’re just starting out or deciding on the right structure for your existing company, understanding the law around business organization is important. You'll have to assess the nature of your business to figure out which option will afford you the most benefits.
SOLE TRADERS
Sole traders are people who start in business or contracting on their own, without registering as a company. Many small business owners, contractors and self-employed people begin as sole traders. It’s the cheapest and easiest option, and may appeal to you if you want to make a living by following your passion, or to work as a contractor.
PROS AND CONS
Upsides include:
It’s easy to set up — you can get up and running quickly
Start-up costs are low — there are no legal or registration fees
You control the business and get all the profits
You can offset losses against other income.
Downsides include:
You’re liable for all debts — this may put your personal assets at risk
It’s harder to grow a sole trader business
Getting loans or investment can be more challenging
It’s harder to sell as a working business.
If you find you want to change your business structure, eg because it’s hard to attract investment as a sole trader, you can register your business as a company.
Tax
As a sole trader, you pay tax on all the income you earn from your work. You can claim work expenses to reduce your income tax.
You’re responsible for all your business debts, including tax and ACC levies, but you also keep control of the business and its profits. At the end of each financial year you must complete a tax return and submit it to Inland Revenue.
COMPANIES
A company, in a legal sense, is separate from the people who own it — its directors and shareholders.
Shareholders are responsible for paying a company’s debts — up to the value of the shares they own in that company. They’re also entitled to a dividend which is a share in the company’s profits.
Doing business as a company can be more complicated than other business structures, eg:
you must file annual returns with both the Companies Office and Inland Revenue
different rules apply to how a company and its shareholders pay tax
details of a company’s directors and shareholders must be provided to the Companies Office.
To help when starting a company, it’s a good idea to get as much advice as you can. Talk to people you know who’ve started companies or who advise business owners, eg accountants and business mentors.
If you think this may be right for you, our website has more information about registering your company and what to do next.
PROS AND CONS
Upsides include:
Shareholders’ liability is limited to the amount they paid for their shares
Your tax rate is lower than top personal rates
You have more credibility in the market
It’s easier to sell a business because it’s a separate entity
The business can grow indefinitely — it’s not tied to one person
It’s easier to get funding and investment.
Downsides include:
There’s more regulation than for sole traders and partnerships
Companies can need more investment to grow
Directors need to understand their responsibilities.
Tax
A company pays tax on its profits — the income left over after taking away expenses. If the company distributes profit to its shareholders, shareholders will pay income tax on the dividend but may also get tax credits to help them meet that obligation.
If a company’s expenses are more than its income, it makes a loss and may not have to pay tax.
PARTNERSHIPS
A partnership is when two or more people or organisations form a business. Partners set out in a partnership agreement how they’ll share profits, debts and work.
It’s a popular structure with professionals, eg architects, lawyers and accountants.
PROS AND CONS
Upsides include:
You can share the load of running a business
Costs are also shared
Partners can specialise and focus on strengths
Partners can bring in more capital investment
You have other people to talk to about the business
Partners can offset losses against other income.
Downsides include:
Each partner is liable for all the partnership’s debts — putting personal assets at risk
You may be liable for your partners’ business debts too.
Tax
A partnership doesn’t pay income tax as a business. It distributes all the income between the partners who then pay income tax on their share.
Each partner is responsible for their own debts. But you can also be responsible for your partners’ business debts, too. At the end of each financial year the partnership must complete a tax return and each partner needs to complete an individual tax return. These are then submitted to Inland Revenue.
Disclaimer: The above article is general in nature and you can contact me for advice tailored to your specific personal situation.
