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When starting a business, careful consideration must be given not only to what the business does, but how it does it. As a business grows, its needs will vary, and if the structure of the business is not flexible enough to accommodate these changing needs, then upheaval, and possible failure, is ahead. Both the present and future should be considered. The structure of the business determines how it is operated; decisions concerning operation should not be made until the structure of the business is known.
There are several alternative business structures. Each structure has distinct characteristics that make it applicable to different styles of business, and although it is possible for a business to operate within any structure, usually the characteristics of one particular structure make it a more appropriate choice than either of the others. Table 1, partially based upon Starting a Small Business (The Commonwealth of Australia, 1992), summarises each structure:
| Advantages | Disadvantages | |
|---|---|---|
| Single proprietorship | ||
| least difficult and expensive to start-up | unlimited personal liability | |
| least amount of regulation | narrowest set of tax advantages | |
| owner in direct control | scarce capital and expertise | |
| all profits to owner | lack of continuity/limited lifespan | |
| Partnership | ||
| easy and inexpensive to form | unlimited personal liability | |
| low regulation | continuity problematic | |
| possible tax advantages | divided authority | |
| additional sources of capital and expertise | difficulty in finding suitable partners | |
| broader management base | disagreements between partners | |
| narrow set of tax advantages | ||
| mutual agency | ||
| Company | ||
| limited liability | closely regulated | |
| ownership is transferable | most expensive and complex to set up | |
| unlimited lifetime | charter restrictions | |
| tax advantages | double taxation | |
| separate legal entity | more expensive for record keeping | |
| many opportunities for capital and expertise | ||
| ownership and control are separated |
Table 1: Business structures and their properties
Deciding which structure is most appropriate for a proposed business requires analysis of the elements tabulated above, with respect to the nature of the proposed business and its predicted future. These elements can be summarised as the distribution of power, sources of capital, taxes and the distribution of profits, regulation, continuity, ease and expense of formation, and liability.
Control over the business is, of course, desirable. In a sole proprietorship, there is only one person who has this control, whilst in a partnership, each partner has equal control, and in a company, control is given to a board of directors (Bazley, Berry, Hancock, Jarvis, 1993). A sole proprietor has the most power but may not be best equipped to deal with every situation, whilst a partnership can share skills it can become deadlocked or politicised, and a company can acquire the best skills available, but at the risk that management make decisions contrary to the best interests of the owners (Bazley et al, 1993). Yet bickering among partners can be alleviated by choosing partners well, and the law provides some protection from managers who make self-interested decisions (Bazley et al, 1993).
Available sources for capital vary with the structure under consideration. A sole proprietor has to rely on finance already available, or increase their personal liability with a loan to the business from an outside source (such as a bank); a partnership has the same options open to it, but with the additional advantage that it can use the pooled resources of each of its partners; a company can use the resources of its owners, or sell itself to new owners if it is a public company (Bazley et al, 1993), or use its presence to attract investment ("venture") capital of its own. Potential backers are aided by regulation's general purpose financial reporting standards, in that reliable, comparable records are available for perusal beforehand, and regulation lends backers added confidence that their money will not be thrown away through improper behaviour (Bazley et al, 1993). This regulation is only applied to companies, so whilst it may be easier to run a sole proprietorship or partnership, the ability to raise finance is not close to that possessed by a company.
Regulation also plays a part in attracting custom. If consumers are aware they are dealing with a firm that can be prosecuted for "misbehaving", they may feel more comfortable parting with their money.
The destination of profits also warrants attention. The sole proprietor can keep 100% of the profits, whilst the partnership must split the profits among partners; both the sole proprietor and the partners pay personal income tax on any profits they acquire (Bazley et al, 1993). Companies pay dividends (a share of the profits) to shareholders, and additionally pay a company tax (Bazley et al, 1993).
Continuity is concerned with the ability of the entity to survive events connected with those in control. A sole proprietorship ceases to exist when the owner dies or becomes bankrupt, whilst a partnership ceases to exist when a partner dies, withdraws or becomes bankrupt, and a company will continue to exist irrespective of the death, withdrawal or bankruptcy of any of its shareholders (Bazley et al, 1993).
The ease and expense with which an entity can be formed is a consideration. A sole proprietor must do nothing to commence business, while a partnership can commence business by a simple verbal agreement (Bazley et al, 1993). A company must make submissions to various bodies such as the Australian Securities Commission (on a regular basis), contract lawyers or accountants to draw up Memorandum and Articles of Association and forms for the regulator, and pay various fees just so it can commence and continue operation. It is far easier, and cheaper, to establish a sole proprietorship or partnership.
Unlimited liability means that the owners of the business are personally responsible for any losses that the business makes (The Commonwealth of Australia, 1992). Such liability is not limited to losses the owner is responsible for, such as selling a product below cost, but all losses for any reason (Bazley et al, 1993). Both the sole proprietor and partnership structures contain unlimited liability. The partnership model is additionally disadvantaged because of mutual agency, the situation where any partner can make commitments on behalf of the entire partnership without specific consent from any other partner (Bazley et al, 1993). This ability can be useful in a professional situation, where a partner can agree to treat a patient or defend a case, but the ability can also be a danger, in that binding contracts can be entered into, and erroneous judgement may tie all the other partners to a situation that they otherwise may have avoided. When considered in context with unlimited liability, the partnership model becomes increasingly unattractive, leaving the company a clear choice as the model best suited to minimising personal risk.
There exist, among others, company forms with limited liability, unlimited liability, and no liability (Bazley et al, 1993). Unlimited liability companies are rare, as shareholders are liable for all the debts of the company, while no liability companies are usually resource-oriented (Bazley et al, 1993). Of relevance is the limited liability form, which can be further split into proprietary (or private) companies, exempt proprietary companies, public companies and companies limited by guarantee, the latter usually being charities or hobbyist associations (Bazley et al, 1993). Proprietary companies require at least two but no more than fifty members, while public companies require at least five members and have no upper limit; proprietary companies are usually owned by families or people who otherwise know each other in some way, while public companies are owned by many people who are usually acting independently of each other (Bazley et al, 1993). Public companies are able to sell their shares to the public, while proprietary companies are not permitted to do so; public companies must abide by more regulation than a proprietary company (Bazley et al, 1993).