Business and Operating Structures
BUSINESS AND OPERATING STRUCTURES: Another in our series of legal resources for creative people about.
- What is a business structure?
- Why do I need to worry about business structures?
- What are the different ways I can structure my business?
- What is a sole trader?
- If I’m a sole trader do I have to use my own name for the business?
- If I’m working for someone else am I still a sole trader?
- Why is it important to establish whether I’m an employee or a sole trader?
- What are the advantages and disadvantages of being a sole trader?
- How much administration is required in being a sole trader?
- What is a partnership?
- Do we have to agree to form a partnership?
- How does the Partnership Act affect us?
- Do we need a written Partnership Agreement?
- What are the advantages and disadvantages of a partnership structure?
- How much administration is required in a partnership structure?
- What is a limited liability company?
- How is a company different to other structures?
- How do we agree how our company is to be run?
- What is a Shareholders Agreement?
- If we are a band is there anything we should specifically include in our Shareholders Agreement?
- How much administration is required in a company structure?
- What are the advantages and disadvantages of a company structure?
- What is a “non-profit” organisation?
- Why adopt a non-profit legal structure?
- Are there different types of non-profit organisations?
- What is a Charitable Trust?
- What makes a trust a “Charitable Trust”?
- What is the benefit of having “Charitable” status?
- Can only trusts have charitable status?
- How do I go about arranging for charitable status?
- How relevant is a non-profit type structure to my business?
The information provided on this blog has been made possible by the funding received by from the New Zealand Law Foundation.
What is a business structure?
When you set up a business, you need some form of trading structure under the umbrella of which you will open a bank account, pay taxes and start trading. It is important that you thoroughly assess your business needs so you choose the right structure, and to help with this, you may need to seek advice from a professional, such as a lawyer, accountant or other type of business advisor.
Why do I need to worry about business structures?
At the outset of most artists’ and creatives’ careers, considerations such as organisational structures are not priorities. However, it is crucial to set up the correct trading structure right from the start, to maximise your income and tax advantages, as well as to ensure that you are not under any unnecessary administrative obligations. As your business and career develop overtime it may also be necessary to make changes to the structure through which you operate, or even adopt an entirely different form of structure, in order to ensure you are putting yourself in the best position possible.
What are the different ways I can structure my business?
There are many ways of operating a business and a number of business structures to choose from, including a sole trader, partnership, limited liability company and a non-profit organisation. The key however is to work out what is the best structure for your particular business or intended operation.
What is a sole trader?
The simplest and easiest way to get started in business is to begin as a sole trader. A sole trader controls, manages and owns the business. A sole trader is personally entitled to all profits and is personally liable for all obligations and liabilities (e.g taxes and debts).
Usually a sole trader can begin a business without following any formal or legal processes to establish it (other than perhaps for IRD and ACC registration).
If I’m a sole trader do I have to use my own name for the business?
If you are a sole trader you don’t have to trade under your own name. For instance, you could call your business “Village Art Supplies”. However in any situation where you are required to give the legal name of your business the correct title will be “[your name] trading as ‘Village Art Supplies’”. This reflects the fact that although the business may have a separate name, at the end of the day it is you personally who is the business.
If I’m working for someone else am I still a sole trader?
If you are doing work for someone else it is very important to establish whether you are an employee or an independent contractor (i.e. a sole trader). In many cases it might be quite obvious that you are an employee, for instance you have signed an employment agreement which clearly defines your status and the employer also has significant control over the work you do and when you do it. There may be other factors which also help to distinguish your relationship as one of employment such as the person you are providing your services to supplies any equipment or supplies that you may need to perform the services in question. However in some situations the distinction between employee and independent contractor can be a fine one.
Why is it important to establish whether I’m an employee or a sole trader?
The consequences of this distinction are significant. In particular, an independent contractor is primarily responsible for their own taxation and ACC levies, whereas in an employer/employee relationship such obligations are the employer’s responsibility. An employee also has rights under the Employment Relations Act.
What are the advantages and disadvantages of being a sole trader?
The main advantage of working as a sole trader is that it is the most flexible form of legal entity. It is simple to set up and to run, and no registration is required in respect of the structure itself. The major disadvantage however, is that the sole trader is entirely liable for any losses or debts that they may incur, putting their personal assets at risk. It is for this reason that people tend to look for ways in which to limit their liability by using a different kind of business structure such as a limited liability company. It can also be harder to attract loans and investment, and the business only lasts for the lifetime of the business owner (unlike a company, which has a “life” of its own).
How much administration is required in being a sole trader?
A sole trader may only require a bookkeeping service, which involves assistance with GST returns, advice on tax deductible expenses, and the preparation of annual income tax returns.
What is a partnership?
In a partnership, two or more people carry on a business in common with a view to making a profit. Their legal relations are governed by the provisions of the Partnership Act 1908.
In a partnership in its purest form, each partner shares responsibility for running the business; personally shares in any profit or loss equally, binds each of his or her partners by the doing of any act in carrying on business for the partnership, and is personally liable for any obligations, liabilities or debt within the partnership.
The partnership itself does not pay income tax. Instead it distributes the partnership income to the partners (with the proportions being determined in most cases under the Partnership Agreement), with the partners then paying tax on their own share.
Do we have to agree to form a partnership?
As there is no formal process that is necessarily required to establish a partnership it does mean that anywhere where two or more people are carrying on business together with a view to making a profit, a partnership will automatically at law be deemed to exist. Consequently a band could well automatically be deemed to be a partnership at law. For some of the reasons set out above (e.g. being jointly liable for any debts or liabilities of the partnership) this can have quite serious personal implications for each individual who is a partner in the partnership. For example if the band owes money, any one member can be required to repay the entire amount owed.
How does the Partnership Act affect us?
In the absence of a written Partnership Agreement the Partnership Act governs the legal relationship between the partners. In particular, it provides that all partners are entitled to share equally in the capital and profits of the business, and must contribute equally to the losses. In this respect, the Act does not make provision for the fact that different members may have contributed different amounts in terms of skills and/or money, and should consequently be entitled to different shares. The Act also provides that any one partner may dissolve the partnership.
Do we need a written Partnership Agreement?
Ideally whenever trading through a partnership structure, the partners in the business should put in place a Partnership Agreement. One of the main benefits of a Partnership Agreement is that it can be used to provide more accurately for the particular needs of the partners in the specific situation compared with the more high level governance and guidance that the Partnership Act provides. So whether you are a group of artists operating a gallery or members of a band or a theatre company, a Partnership Agreement can help you more specifically provide for the issues that will be important for you. It is recommended that advice is taken from a lawyer experienced in this area, and that wherever possible a Partnership Agreement is drafted that covers all contingencies and possible conflicts that might arise between the partners. However even if only a few of the key issues are dealt with it is better than having nothing in place.
What are the advantages and disadvantages of a partnership structure?
A partnership can be a useful way to share business administration costs, and again, no registration of the structure itself is required to start trading. However, as discussed above, partners may be liable for debts incurred by other partners, personal assets may be at risk and there is potential for conflicts amongst the partners and possible complications if a partner dies or wishes to leave the partnership.
How much administration is required in a partnership structure?
A partnership may have anything from, similar administration requirements to a sole trader business where for instance there are only two individual partners involved, right through to much more complex administration requirements in the situations where the partners themselves are companies or trusts. The size of a partnership would also of course dictate the level of administrative services required by the partnership.
What is a limited liability company?
A limited liability company is the most common way by which people choose to do business. A company exists as a legal entity in its own right. It is legally separate from its shareholders (or owners) and its directors (or managers). Companies are incorporated under the Companies Act 1993. A person, or a group of people or even another company can own shares in a company. The company owns the assets of its business, is responsible for any debts or other liabilities; is responsible for paying tax on its income and keeps any profits for itself or may distribute such profits to its shareholders.
How is a company different to other structures?
Some of the key structural differences between a limited liability company and the other structures mentioned in this Fact Sheet which make a limited liability company an attractive business structure include:
- Limited Liability: A shareholder’s liability for losses incurred by a company is limited to the extent that the company has not been fully paid for the shares issued to the shareholder. If fully paid, then the shareholder has no further liability. Lending institutions and some creditors will sometimes however try to get around the limited liability nature of a company by requiring company directors and/or shareholders to give personal guarantees for company obligations or for company debts. Personal liability may also attach to a director (or to a person who is deemed to have been acting as a director) if a company has been trading in a situation where it can’t pay its debts or is considered to be trading recklessly.
- Perpetual succession: This means that the company continues to exist irrespective of any changes of ownership of its shares.
- Tax: There are various reasons why it may be advantageous to form a company for tax purposes. In particular, the company pays tax at a different rate from the shareholders’ personal tax rates. Everyone’s personal situation is different though and specific advice should always be sought on these issues from an accountant.
- Shares: Shares can be on sold to other people.
- Rules: The rules of the company are clear through both its constitution (if it has one) and the Companies Act 1993.
How do we agree how our company is to be run?
In the first instance the Companies Act will dictate generally how a company is to be run and the obligations that are to be met. However a company can also put in place a Constitution by which more specific provision can be made for how the company is to operate, compared with the general arrangements provided for by the Companies Act.
What is a Shareholders Agreement?
In addition to a Constitution the shareholders of a company may also decide to put in place an agreement between them that even more specifically provides for their individual interests in terms of how the company is run. This is known as a ‘Shareholders Agreement’. The other benefit of using a Shareholders Agreement is that a Shareholders Agreement is a private document where as a Constitution will be registered with the Companies Office and freely available for anyone to view. In other words within a Shareholders Agreement the shareholders can provide for certain things that they may not necessarily be comfortable with just anyone knowing about.
If we are a band is there anything we should specifically include in our Shareholders Agreement?
The issues to be dealt with in a Partnership Agreement and a Shareholders Agreement are in fact relatively similar although with some obvious differences which relate back to the different characteristics of the company and partnership structures themselves. The following is a more specific outline of some of the types of practical issues that bands need to deal with no matter what legal structure they decide to conduct their business through:
- Sharing of profit and losses: Are all members to share in all income generated from the activities of the band equally?
- Assets: It is important to establish what equipment and property (e.g. master recordings and videos) belongs to the band, and what belongs to the individuals.
- Decision making and authority: Who decides what? Does everyone have to agree on everything or is a majority decision sufficient? It may be that certain types of decisions can be left to one or two members whereas others require everyone to agree.
- Leaving members: How can someone be removed from the band? Some consideration should also be given to a leaving member’s entitlement to a share of the property of the band, and how that share is to be calculated and paid.
- Group name: A name can be one of the most valuable assets of a band. If the band breaks up, who is entitled to go on using the name?
How much administration is required in a company structure?
Administering a company will require meeting the various reporting requirements of the Companies Act 1993 including the preparation of an Annual Report including full annual financial statements and various other information in respect of the company as well as complying with the various resolution and other record keeping requirements of the Act generally. The company and shareholders may also require tax planning services to minimise tax and also general tax advice during the course of the trading year.
What are the advantages and disadvantages of a company structure?
Under a company structure, it is generally easier to attract funds and investment, as investors can become shareholders, and as a company is an independent legal entity, it is also easier to sell the business or pass it on to others. A company also sustains more credibility in the market place. The shareholders’ liability for losses is also generally just limited to the money they have to date paid or agreed to pay for their shares, except where they may have given personal guarantees for company debts. This is in direct contrast with partnerships or sole traders where the individuals involved are personally liable for any debts incurred while trading. It is also essential that anyone acting as a director of a company clearly understands their responsibilities and obligations under the law as reckless trading by the company or trading when the company is not able to pay its debts can lead to the directors being held personally liable for the debts of the company.
The disadvantages of utilising a company structure are generally perceived as being the effort and expense involved in forming, operating and winding them up. Companies do require a lot of paperwork, both in their establishment and ongoing operation. Taxation issues such as fringe benefit taxes and
dividends further complicate matters. None of these problems are insurmountable. What they mean is that to enjoy the benefits of limited liability, it is necessary to spend a little more time and money establishing and running the company appropriately.
Whether or not the benefits of the company structure are worth the time and expense in any specific situation is dependent upon a number of factors. If you don’t own anything of value, or if the trading debts you are likely to incur are minimal, then being personally liable for all your trading debts may not be of concern. However, if you are exposing yourself to financial risk through your creative activities, and especially if you have something to lose in terms of your personal assets, trading as a limited liability company may be worth investigating.
What is a “non-profit” organisation?
In the case of a non-profit organisation any income earned in excess of the running costs of the organisation is re-invested back into the organisation itself. In contrast to what may occur in a partnership or a limited liability company, any such excess income or ‘profit’, is not distributed to the individual members. It should be stressed however that such “non-profit” organisations may in fact make a profit it is just that these profits can not be distributed for the personal benefit of their members or managers. A non-profit organisation can also still pay market rates for any services it is provided and can also employ or contract staff on normal commercial terms.
Why adopt a non-profit legal structure?
Such organisations are particularly appropriate where government or community funding is a major source of income, as such funding is often unavailable to the more traditional profit orientated organisations such as limited liability companies. Non-profit type structures may also be more appropriate where the continuing goals and objectives of the organisation itself are seen as more important than those of the individuals who comprise the organisation or where the organisation has a particular community or public benefit objective. Consequently, non-profit organisations are not the best structures to run a traditional business through, as after all, a traditional business is all about generating profit for its owners.
Are there different types of non-profit organisations?
Probably the most common form of non-profit organisation in New Zealand is the incorporated society. A society which is incorporated under the Incorporated Societies Act 1908 has an independent legal identity which means that the society can enter into contracts without subjecting its members to personal liability. This is however provided that the subject matter of these contracts is within the stated objective of the society and does not involve passing any income or assets of the society on to members of the society for their own personal use outside of the activities of the society. The society will
also continue to exist irrespective of changes in its membership. For more specific information on setting up and running an incorporated society please refer to the Societies and Trusts website at www.societies.govt.nz.
What is a Charitable Trust?
Another common type of non-profit organisation in New Zealand is a Charitable Trust. Where as an incorporated society can have a wide range of members who can ultimately have a say in the running of the incorporated society, a Charitable Trust is, as the name suggests, essentially a trust structure. This means that a limited number of trustees will have ultimate independent authority in terms of the operation of the Charitable Trust. A Charitable Trust type structure may be more appropriate where the organisation has specific goals that it intends to meet through its activities rather than serving as an umbrella organisation for a large number of people with shared interests or goals whose number may change from time to time, which is the type of situation when an incorporated society may be a more appropriate structure.
What makes a trust a “Charitable Trust”?
To qualify as a Charitable Trust a trust would have to have certain objects that the law regards as charitable. Unfortunately the legal definition of what is charitable can differ from how the word ‘charitable’ is often understood in common practice. So for instance a non-profit organisation with what most people would consider good and worthy objectives may not necessarily qualify as being charitable in the eyes of the law. The number of people who will benefit from the activities of the trust and how they qualify to receive any such benefits will also help to determine whether a trust is truly set up for a charitable purpose in the eyes of the law. For more specific information on setting up and running a Charitable Trust please refer to the Societies and Trusts website at www.societies.govt.nz.
What is the benefit of having “Charitable” status?
Aside from the practical benefits of perhaps being able to access certain funding and grants that would not be available to a non-charitable organisation, charitable status also carries with it certain tax advantages such as certain exemptions from having to pay income tax on income received by the charitable entity.
Can only trusts have charitable status?
It is not just trusts that can acquire charitable status. For instance an incorporated society if it meets the necessary legal and procedural requirements could obtain charitable status and indeed there are a number of incorporated societies who do have such charitable status.
How do I go about arranging for charitable status?
The way in which the charitable sector in New Zealand is overseen has recently been changed by the Charities Act 2005. The Charities Act established an organisation known as the Charities Commission that now has chief responsibility for dealing with established and new organisations or entities seeking charitable status in New Zealand. For anyone considering establishing a charitable entity or seeking charitable status for an existing entity, you should consult with a lawyer who has experience in this area. The Charities Commission website (www.charities.govt.nz) also has a great deal of useful information on applying for and maintaining charitable status as well as its associated benefits.
How relevant is a non-profit type structure to my business?
Non-profit organisations are probably not appropriate for the average “working” creative, however certain activities undertaken by groups of artists or musicians may be well suited to a non-profit type structure, especially where there is some emphasis on the cultural or community benefits which may accrue from those activities.
Written by entertainment lawyer David McLaughlin.