By Peter Gandolfo, Partner
Sarah Papas, Senior Associate
Before going into business with someone, you have to balance the advantages and disadvantages of working with them. How can you protect yourself if things go badly? How can you best take advantage of the arrangement if they go well?
The business structure you choose might determine the tax you are liable to pay, how you can best protect your assets, and the ongoing costs.
The two most commonly used business structures for people going into business with one another are companies and partnerships.
The main advantage of a company over a partnership is the ability to protect your assets.
A company is its own ‘legal entity’, which means that it has the same rights as a legal person in that it can sue, be sued and incur debt. A company’s owners can limit their personal liability and will generally not be liable for the company’s debts.
Business is already a risky enterprise but having to rely on another person in the day to day running of that business can increase this risk. By having the company liable for debts incurred, you don’t face as large a threat in having your own assets called in to pay for costs that may have been incurred by your business partner. In the vast majority of cases, the liability incurred by a company is limited to assets owned by the company itself.
You can sell shares in your company to other people, which is helpful when you want to expand your business through investment from third parties. By offering them equity, investment in your business becomes far more appealing.
There are some downsides. A company can have higher establishment and running costs than other types of business structures. You will either need to know or employ someone who can inform you of your obligations and how to comply with them under the Corporations Act 2001.
The money earned by the company belongs to the company and its shareholders. This can become particularly frustrating where there is an equal division of shares between yourself and another person, and you consider the other person is not bringing in as much business or contributing as much time and effort to the company. Disputes can be expensive to resolve.
A written shareholder agreement is the best protection against future disputes. You should take the time and trouble to iron out any contentious issues between you before the company starts operations.
Although less common than companies, partnerships may be worth considering in the right circumstances, and there are many benefits.
Business losses are shared equally and in some circumstances, partners can receive a capital gains tax discount when lodging their personal tax returns. A well-drafted partnership agreement will clearly articulate:
- Each partner’s role, duties and level of authority
- Each partner’s initial and ongoing financial contribution to the partnership
- A procedure, outside of the courts, for resolving disputes between partners
- A procedure for ending or resigning from the partnership agreement.
Unlike in a company where you may find yourself unfairly having to contribute more than a co-owner, partnership agreements can be drafted to allow you to explicitly detail your expectations and the consequences of non-compliance if a partner isn’t making a fair contribution.
Relative to other business structures, partnerships are simple and inexpensive to establish, and have minimal reporting requirements.
Because partners are not employees, superannuation contributions and workers’ compensation insurance may not be payable for partners, which means significantly less paperwork. It can also be easier to exit by dissolving the partnership or resigning and recovering your investment.
As with all business structures, there are also disadvantages to a partnership structure.
Unlike companies, a partnership is not a separate legal entity. This means that each partner will be held fully responsible for the debts and liabilities incurred by other partners. The fact that you were not aware of these debts and liabilities will not be a defence.
In some cases, changes in ownership can be difficult. This is particularly the case when one partner is resigning and another is taking his or her place. More often than not, this will require a new partnership agreement.
Given the shared liability of each of the partners, getting the agreement right is extremely important. Disputes over partnership agreements very often become litigious and can become expensive.
It is important to seek legal advice early when you are considering going into business with a partner or partners. An experienced lawyer can help you work through the initial questions to establish which structure is best for your circumstances and then prepare the documents in a clear and concise way so as to assist your business into the future. They can also work closely with your accountant on taxation issues. Remember to agree on the terms in writing before your business relationship starts.
The best advice is to Contact Partners Legal on 1800 333 243 to arrange an obligation-free 30-minute consultation.
This article is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this article to specific issues or transactions.