A business structure is a legal entity. Business.gov.au can help you decide which business structure best suits you needs. In Australia, which is typical of developed economies in this respect, the following main choices exist:
This is an individual, a person, who has legal responsibility for all aspects of the business, including any debts and losses, which cannot be shared.
Despite the word ‘sole’, a sole trader may employ others in his/her business.
This is the simplest and least expensive business structure, with maximum personal control. Changing it to an alternative business structure is simple. Thus it may be attractive for IP ventures at an early pre-commercialisation stage, or for micro ventures.
However, it can have disadvantages:
- it does not permit multiple entities to share ownership or control , which can be unacceptable to IP venture funders and other venture participants.
- it has unlimited liability; all the sole trader’s personal assets (not just business assets) are at risk if the business fails.
- business profits or losses cannot be split with family members in order to take advantage of a common tax arrangement that allows a reduction in tax payable.
These three disadvantages are addressed to variable extent in each of the alternative business structures described below.
A partnership is a business structure in which two or more people carry on a business together. A written partnership agreement is prudent but not mandatory.
A partnership may overcome disadvantage (a) listed above in an inexpensive manner, but it still suffers from disadvantages (b) and (c). Therefore it is likely to be attractive for IP ventures only at a pre-commercialisation stage, or for micro ventures.
The partnership may employ people who are not partners. The partners share income, losses and control of the business. As with a sole trader entity, it’s not legally separate from the people in it, meaning each partner is personally liable for partnership debts, including their share of the partnership tax obligations.
Private company (Proprietary company)
A private company is a legal entity with, for control purposes, at least one person as a director who has responsibilities governed by the Corporations Act 2001. It has at least one shareholder, not necessarily a person, as owner(s). Unlike a sole trader or a partnership, it’s a separate entity from its directors and shareholders – profits, losses and tax obligations belong to the company.
Shares may be sold, but not publicly.
The Australian Securities and Investments Commission (ASIC) regulates companies. Each company has its own set of rules, its constitution.
Pty Ltd is an abbreviation for Proprietary Limited that is often placed at the end of the company name. ‘Proprietary’ means the company is privately held and ‘Limited’ means the liability of each shareholder to pay company debts is limited to the amount unpaid (if any) for his/her shares in it. (Proprietary companies can by choice be unlimited.) Most small companies in Australia are Pty Ltd companies.
A Pty Ltd company almost comprehensively overcomes disadvantages (a) and (b) mentioned above, i.e. excessively limited control and ownership, and unlimited personal liability.
Further, particularly in combination with the use of trusts (described below), the tax-related disadvantage (c) is alleviated in companies.
A private company is relatively complex and expensive to establish and maintain. However, for on-going small-to-medium IP ventures, it’s a highly practical, flexible and robust business structure.
Unlike private companies, public companies may sell their shares publicly.
They may be ‘listed’ or ‘unlisted’. Listed public companies are included in the official list of a prescribed financial market such as the Australian Securities Exchange (ASX) where their shares can be bought and sold by the public.
For large IP ventures in particular, this business structure may facilitate the raising of funds by increasing the number of potential shareholders.
A disadvantage when a company is publicly listed is that shareholders usually demand some control in a manner that may be difficult for the original venture participants to manage.
In addition, because ownership is public, the conduct of the business must be transparently of high integrity; this increases the management workload and costs. A potentially disadvantageous consequence is that public companies must have at least three directors, two of whom must be Australian residents.
A trust is a business structure in which a legal obligation exists on a person or company, known as a ‘trustee’, to hold assets for the benefit of others, known as ‘beneficiaries’. The trustee is legally responsible for the business’ operations. It’s important to note that you cannot register a trade mark or design registration under the name of a Trust.
A formal trust deed is mandatory to define how the trust operates and who the beneficiaries are, so a trust is generally as complex as a company, but less flexible as regards control. Therefore it’s not usually appropriate as the main business entity for commercialisation.
However, when the trustee is a private company, the trust operates like a private company, and the beneficial features of a private company mentioned above can be realised for small ventures.
Many trusts have an additional legal advantage: they enable a person who is a beneficiary to split his income amongst family members so that he/she can reduce the overall family tax payable (in contrast to disadvantage (c) mentioned above for sole traders).
This advantage is a significant consideration at the very beginning of a commercialisation venture. A person with shares in a company formed for commercialisation purposes may benefit by having his/her shareholding registered on behalf of a trust rather than him/herself.