Business Structures
Episode #9 of the course Introduction to accounting by Martin Ryan
Business structures can vary around the world, particularly in tax treatment and liability law. Today’s lesson covers these structures at a general information level.
There are three main types of business structure: sole trader, partnership, and company. The main differences between them are the number of people who can be involved in each structure and the level of risk the parties involved in the structure are exposed to.
Sole Trader
A sole trader is also known as a sole proprietorship. People may start up their own business and not bother with any of the legalities. This means they fit into the sole trader category. It is extremely easy to get into this category—there is no need to do anything.
In this structure, there is a single person at the head of the firm. Such person is deemed to be the business, so anything that happens is not seen to be done by a company or business, they are deemed to be done by the person.
The bad news is that this means that if anything goes wrong, the owner is liable as a person. If something goes wrong and the owner is taken to court, then they may lose their personal possessions, as well as their business possessions.
Partnership
A partnership is much like sole trading, except there will be more than one person involved in the business. Like a sole trader, everything done is deemed to be done by those people, not by the business, because they are not legally separate.
Again, if something goes wrong, a partner is personally liable for damages. And if one partner or any employee does something wrong, then all the partners are jointly liable. Local tax laws can vary on how much each partner is liable.
Partnerships usually have a partnership agreement that sets out things like how a new partnership will be formed if one partner leaves and how profits and losses will be distributed among the partners.
Companies/Corporations
Limited liability companies, also known as corporations or LLCs, are a very different structure from partnerships and sole trading. Companies are separate legal entities in their own right. When talking about a partnership or a sole trader, it is possible to use the names of the people and the name of the business interchangeably, as they are legally one and the same. In the case of a company, there is no person or people that the business revolves around. It is an entity entirely on its own, separate from people altogether.
A company is also owned in a different way from the other structures. The owners in the other structures are the people who run the business. The owners of a company, on the other hand, are the shareholders, also known as stockholders. They buy shares in the business and own a little piece of the company.
The shareholders’ liability—that is, what they will lose if the company is sued or liquidated—is limited to the amount of money they have invested in the shares. This means that if anything goes wrong, there is no person that can be pursued for damages, as only the company can be pursued, and the amount of damages that can be recovered is limited to the assets of the company. This is why they are called “limited liability” companies.
There are two types of company: public and private. A public company trades on the stock exchange, which means anyone can buy their shares. Private companies are not traded on the stock exchange, but shares can be sold to friends and family. Private companies are the structure of choice for most small businesses.
If you are thinking about starting a business, talk to your accountant about the best type of structure for you.
Tomorrow, we’ll finish off by looking at a couple of variations in accounting.
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