Understanding Business Structures
You are a newly hired junior associate in an accounting and professional services firm that provides business advice to its clients.
Your supervising partner has allocated you a new file to test your knowledge and skills. The partner instructs you to attend a meeting with the clients and then provide him with a report containing advice on the best way forward.
The choice of business structure is a crucial one for any person running the business. The reason for this is that each business structure is marked by their unique features and each of these structures has risks associated with them. The business structures relevant for this discussion are sole trader, partnership and company as these are the prominent business structures in the nation. The features and the risks associated with these structures also enables one to judge the presence of exactly which business structure is being followed by people[1].
This report is concerned with the analysis of the present business structure of the clients of the firm, i.e. of Mr and Mrs Smith. Once the business structure is analysed, a recommendation would be drafted for them for their future business structure based on the requirements stated by them, with proper justifications.
Before beginning the analysis of the business structure being presently followed by the couple, there is a need to clear the basics of the business structures. Sole trader is a business structure in which the business is run entirely by a single proprietor. The proprietor is free to hire employees to assist him or her in the work but the ownership of the business continues to be in their hand. This form of business structure has full independence of the proprietor but has the limitations of limit funds availability[2].
The next business structure is partnership, which is run by two or more people, for a common person, in a joint manner, and where the profits and losses are shared equally between the partners, unless otherwise provided in the partnership deed. The partnership deed is not an obligation and a common understanding between the people with the features of partnership is enough for presence of partnership[3]. In Australia, each jurisdiction has separate partnership act, and in Victoria, the Partnership Act, 1958[4] is applicable. The definition of partnership has been covered under section 5 of this act, where the partnership is formed when two or more people run a common business and share profits[5]. Under section 6 of this act, the rules for determining the presence of partnership have been covered. It covers common joint property, sharing gross returns, receipt of profits and losses, and other details[6]. Section 10 of this act provides that the partners have the liability of actions undertaken by the partnership firm where the business is run in a common manner with the intention of running the business[7].
The facts given in the case of Mr and Mrs Smith shows that the business which they were running, was a partnership; instead of their view of it being a sole trader. The reason for saying this stems from the features of the business which they were running. The business was being run by the two in a joint manner, and it is assumed that the profit of the business was being shared commonly between them as nothing otherwise is stated. When one year back the business was being operated, it was being run in a sole trader form as Mrs Smith was solely handling the catering business operations. When Mr Smith joined her in the work, after quitting his job, it became a partnership. This is due to the fact that Mr Smith was not hired as a worker who was working for Mrs Smith. Mr Smith was working “with” his wife, which shows the presence of joint ownership. Just because the name in all the contracts of business was in name of Mrs Smith, it does not mean that a sole trader form of business was present. This is due to the fact that a contract entered by one partner is deemed as a contract of the partnership firm, by which all the partners are bound[8]. So, irrespective of the name of one or all partners on the contracts of the firm, a partnership business is present. The fact that Mr and Mr Smith knew that they were running the business together is enough to show that a partnership was present in this case.
Analysis of Mr. and Mrs. Smith’s Present Business Structure
The partnership form of business structure has a number of risks associated with it, which stems from the various demerits of this business structure. The prominent ones include:
- Unlimited liability: In partnerships, the partners have unlimited liability. This means that in cases of the partnership coming to an end, where the partnership is unable to pay off its debts, the remaining amount of unpaid debts is to be personally borne by the partners, even if it means selling off their personal assets.
- Joint liability: The partners are jointly and severally liable for the acts of other partners, owing to the operation of agency law on partnerships. So, the acts of one partner are binding upon the others.
- Disagreement resulting in dissolution: Where there is a dispute between the partners and it remains unresolved, the partnership can come to an end.
- Revaluation: Upon a partner leaving or being added in the partnership, the firm has to be re-valued, which proves to be a costly affair[9].
As it has been clearly proven above that a partnership form of business structure was being carried on between Mr and Mrs Smith, the advice now needs to be drawn for the business structure which suits their future needs, where they could handover the business to their three children upon them retiring and the business being run by the three children where each of them have equal say in the manner in which the business is run. In this regard, the best option for them is to opt for a company from of business structure. The reasons for this recommendation have been justified below.
A company form of business structure which is deemed as a legal entity made of association of people for carrying on commercial activities. The Corporations Act, 2001[10] is applicable on the companies in the nation and this makes it easy for the people running the business to follow a single act, instead of having to track down the provisions of the pertinent act applicable in particular jurisdiction as is the case with a partnership form of business structure. A company form of business structure helps in overcoming the shortfalls of the partnership form, as in this form there is limited liability of the shareholders. The shareholders of the companies can only be made liable in cases of winding up for such sum of money which is unpaid on their shares[11].
The next merit of this form is that the companies can easily raise funds from public, apart from the usual sources of finance, by offering the public the shares of the public. For this purpose, a decision has to be made between the type of company which is chosen, and the choice is between public company and proprietary company. The former can raise funds from general public; whilst the latter has restriction on doing the same and can raise funds only from known people. The most important advantage of this form of business structure is the easy transferability of ownership. Where the ownership has to be transferred in this form, it can be done by simply by transferring the shares[12].
In the given instance, by choosing a company form of business structure, for expanding their business, Mr and Mrs Smith would be able to raise funds from the shareholders. As the affairs of the company are public, they should opt for proprietary company, which would enable them to raise funds from their friends and still keeping their business less public in comparison to a public company. This would also help in keeping the level of compliances less in comparison to a public company, as the private companies have less compliance regulations. This would help in dealing with the drawback of the company form of business structure having more legal compliances in comparison to a partnership form. Through this form, they would be easily able to transfer the ownership of the business equally between the three children, by transferring equal number of shares to the children.
Risks Associated with Partnership Business Structure
This would give them the advantage of having a separate legal entity as the companies have this status. As a result of this, neither the couple, nor their children would have to be made personally liable in case the company is unable to pay their debts. There is also a separation of management, which would ensure that the company would be run by elected directors and the couple and their children can continue to be merely the shareholders. This would bring specialization to the board of the company which the couple would form. The company form of business structure is governed through replaceable rules or constitution, and this choice depends upon the choice of the people forming the company[13].
They need to be made aware of the risks associated with company form of business structure too, so that a clear decision can be undertaken by them. The costs of forming and maintaining a company are higher than any other business structure discussed here. The people running the business in this form have various liabilities under the governing act[14]. A key disadvantage of this form is that there are far more reporting requirements in company form of business structure, in comparison to sole trader or partnership. This would require the couple to opt for legal consultation, meaning additional costs.
Conclusion
Thus, based on the analysis conducted of the requirements of the clients, it is recommended to them to transfer their present business structure of partnership, to company business structure. This would help them in expanding their business, and also in easily transferring their business to their children where they would have an equal say in running the business. Even though this would mean higher compliances, the advantages of this form suit their requirements in the best possible manner.
Articles/ Books/ Journals
Carrington A, Business Structures and Incorporation (Aauvi House Publishing Group, 2012)
Cassidy J, Concise Corporations Law (The Federation Press, 5th ed, 2006)
Gibson A, and Fraser D, Business Law (Pearson Higher Education AU, 2013)
Latimer P, Australian Business Law 2012 (CCH Australia Limited, 31st ed, 2012)
Plessis JJD, Hargovan A, and Bagaric M, Principles of Contemporary Corporate Governance (Cambridge University Press, 2nd ed, 2010)
Story J, Commentaries on the Law of Partnership, as a Branch of Commercial and Maritime Jurisprudence, with Occasional Illustrations from the Civil and Foreign Law (The Lawbook Exchange, Ltd., 2007)
Wagen LVD, and Goonetilleke A, Hospitality Management, Strategy and Operations (Pearson Higher Education AU, 3rd ed, 2015)
Legislation
Corporations Act, 2001 (Cth)
Partnership Act, 1958 (Vic)
Others
Tasmania Government, Partnership – advantages and disadvantages (2017) <https://www.business.tas.gov.au/starting-a-business/choosing-a-business-structure-intro/partnership-advantages-and-disadvantages
Ann Carrington, Business Structures and Incorporation (Aauvi House Publishing Group, 2012)
Paul Latimer, Australian Business Law 2012 (CCH Australia Limited, 31st ed, 2012)
Andy Gibson and Douglas Fraser, Business Law (Pearson Higher Education AU, 2013)
Partnership Act, 1958 (Vic)
Partnership Act 1958, s5
Partnership Act 1958, s6
Partnership Act 1958, s10
Joseph Story, Commentaries on the Law of Partnership, as a Branch of Commercial and Maritime Jurisprudence, with Occasional Illustrations from the Civil and Foreign Law (The Lawbook Exchange, Ltd., 2007)
Tasmania Government, Partnership – advantages and disadvantages (2017) <https://www.business.tas.gov.au/starting-a-business/choosing-a-business-structure-intro/partnership-advantages-and-disadvantages>
Corporations Act, 2001 (Cth)
Jean Jacques du Plessis, Anil Hargovan and Mirko Bagaric, Principles of Contemporary Corporate Governance (Cambridge University Press, 2nd ed, 2010)
Julie Cassidy, Concise Corporations Law (The Federation Press, 5th ed, 2006)
Ibid
Lynn Van der Wagen and Anne Goonetilleke, Hospitality Management, Strategy and Operations (Pearson Higher Education AU, 3rd ed, 2015)
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
