There are a few legal entities that you can register your business as when you first start up. Each entity has its own structure and different legal and financial obligations. The structure that you choose can affect your ability to grow or sell the business later, so it’s important to get it right from the beginning. A couple of things that you want to think about are:
• Will you want to look for investors?
• Is this a business that you will work to grow?
• Will you want to sell this business one day?
Once you’ve answered those questions look at the types of legal entities that you can register as and see which one is right for you.
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Types of legal entity
Sole trader
A sole trader is basically what it sounds like. Most people that are independent contractors, small business owners, and self-employed are sole traders.
Advantages of being a sole trader are:
• It’s easy and quick to set up
• Start up costs are low as there are no legal or registration fees
• You control the business and get all the profits
• You can offset losses against other income
• It’s easier to change the structure to a company if you are finding it hard to attract investors
• You can claim work expenses to reduce your income tax
Disadvantages are:
• You are liable for all debts, which can be a risk to your personal assets, including tax and ACC levies
• It’s harder to grow a sole trader business
• Getting loans or investments can be more challenging
• It’s harder to sell as a working business
• If you hire staff, you’ll have to register as an employer with IRD and meet a number of legal obligations
Companies
A company is legally separate from the people who own it, namely the directors and shareholders. Shareholders are responsible for paying a company’s debts up to the value of the shares that the own in that company. They’re also entitled to a dividend which is a share in the company’s profits. It’s more complicated to operate as a company as you have to file annual returns with the Companies Office and IRD, among other things. There are three types of company in New Zealand:
Limited Liability Company
These are the most common type, and are recognised by having Limited, Ltd., or Tapui at the end of their name. Limited liability companies have full responsibility for all of its legal and financial obligations. The liability of the shareholders that’s limited.
Co-operative companies
Sometimes called co-ops, these are limited liability companies that are owned and controlled by the members.
Unlimited companies
These are quite rare as they don’t limit a shareholder’s liability for company debts.
Advantages of companies are:
• Shareholders’ liability is limited to the amount they paid for their shares
• Your tax rate is lower than top personal rates as it only pays tax on its profits
• 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
Disadvantages are:
• There’s more regulation than there is for sole traders and partnerships
• Companies can need more investment to grow
• Directors need to understand their responsibilities
• If you hire staff, you need to register as an employer with IRD and meet a number of obligations
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 usually popular with professionals like lawyers and accountants.
Advantages of partnerships are:
• You can share the load and costs of running a business
• Partners can specialise and focus on their strengths
• Partners can bring in more of capital investment
• Partners can offset losses against other income
Disadvantages are
• Each partner is liable for all the partnership’s debts, putting personal assets at risk
• You may be liable for your partner’s business debts too
• If you hire staff, you will need to register as an employer with IRD and meet a number of legal obligations.
Trusts
A trust is a structure where a trustee carries out the business on behalf of the trust’s members or beneficiaries. A trust is not a separate legal entity. A trust can be a sole trader or a company. The trustee is legally liable for the debts of the trust and may use its assets to meet those debts, however if there is a shortfall the trustee is responsible for the difference.
Advantages of trusts are:
• Reduced liability, especially if you are a corporate trustee
• Assets are protected
• There’s flexibility of asset and income distribution
Disadvantages are:
• They can be expensive and complex to establish and administer
• They’re difficult to close or make changes to once they’re established
• Any profits retained to reinvest into the business can incur penalty tax rates
• You can’t distribute losses, only profits.
If you’ve got any questions about the kind of business you should register as, check out MBIE’s business structure overview on their website.