One of the first major decisions you will have to make as you start your new business is the form of legal entity it will take.
The form of entity you choose can have a significant impact on the way you are protected under the law and the way you are affected by taxation rules and regulations.
There are four basic forms of business organisation. Each has its own benefits and drawbacks and is treated differently for legal and tax purposes.
A sole proprietorship is typically a business owned and operated by one individual.
The owner has possession of the business assets and is directly responsible for the debts and other liabilities incurred by the business.
The profit or loss of a sole proprietorship is combined with the other income of an individual for income tax purposes.
A sole proprietorship typically does not have any rules or operating regulations under which it must function. The business decisions are solely the result of the owner’s abilities.
In a partnership, two or more individuals join together to run the business enterprise.
Each of the individual partners has ownership of partnership assets and responsibility for liabilities, as well as authority in running the business.
The authority of the partners, and the way in which profits or losses are to be shared, can be modified by the partnership agreement.
The rights, responsibilities and obligations of partners are typically detailed in a partnership agreement. It is a good idea to have such an agreement for any partnership.
A partnership is a legal entity recognised under the law and, as such, it has rights and responsibilities in and of itself.
The Limited Liability Partnership (“LLP”) offers limited liability to its members but, like a traditional partnership, is tax transparent and offers flexibility in terms of its internal organisation.
An LLP is a separate legal entity from its members.
Therefore, it may enter into contracts and deeds, sue and be sued and grant floating charges over its assets in its own name.
This avoids the problems that exist in relation to partnerships, where technically it is often necessary for every partner to be party to certain documents or litigation, and the creation of floating charges is not possible.
A limited company is a separate legal entity that exists under the authority granted by statute. A limited company has substantially all of the legal rights of an individual and is responsible for its own debts.
It must also file tax returns and pay taxes on income it derives from its operations.
Typically, the owners or shareholders of a limited company are protected from the liabilities of the business.
However, when a limited company is small, creditors often require personal guarantees of the principal owners before extending credit.
The legal protection afforded to the owners of a limited company can be useful.