Business structure basics
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You probably didn’t start a course in Web3 thinking you’d learn about the basics of business structures. But this information is important. In starting any business, you must actively consider what business structure you should adopt. If you do not take an active decision at the front end, the law will impose a default position on you at the back end depending on the circumstances.
The business structure in place will determine matters like:
- legal liability for the debts or claims against the business
- control over the decision making over the operating rules and day-to-day management of the business
- ability to raise funds for business operations
- compliance and disclosure requirements
- taxation treatment.
Importantly, the business structure will also impact exit (i.e. sale of business) decisions.
In this article we will consider the characteristics of five different business structures:
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- Sole trader
- Joint venture
It is not an exhaustive list, as each jurisdiction will have its own options and variations. But the five for-profit structures considered here will be available in most common law jurisdictions (including Australia, Canada, Hong Kong, India, Singapore, the United Kingdom and the United States).
A sole trader is where a single operator owns and controls their business, in their own name. The person is legally responsible for all aspects of the business including ownership of assets, employment of staff, liability for any services provided and responsibility for complying with relevant regulations. This structure may be implied where, for example, an individual is providing services as a consultant to another entity.
Key advantages include the lack of formality (making starting up and winding down straightforward and inexpensive) and complete control over the business.
Key disadvantages include unlimited liability for business debts, and the lack of ability to raise capital without risking personal assets as collateral.
A partnership exists where two or more persons carry on a business in common with a view to profit. The partners of the business share the profits and share the legal risk (partners are jointly and severally liable). Partners may enter into a binding partnership agreement which governs how business decisions will be made. If there is no partnership agreement, a partnership can still be implied by law if it meets the above definition. A partnership is not a separate legal entity but partners would maintain a partnership bank account, for instance.
The key advantage of the partnership structure is that you have partners (to pool capital and experience, share the workload and operate at a larger scale than might be possible as a sole trader). Similar to sole traders, there is a low degree of formality involved in establishing a partnership business.
The key disadvantage is that you have partners. While you may not have a control over decisions you have an unlimited liability for partnership debts. Selling your interest in the partnership can also be difficult.
A joint venture differs from a partnership in that it is a contractual relationship for a specific time or a specific task rather than a business in common, and joint venture partners do not share profits. A joint venture might exist between two or more individuals (see sole trader, above) or corporate entities (see private and public companies, below).
Joint ventures are regularly used in Web3 for existing businesses that want to collaborate on a joint project. As an example, in 2022 it was announced that Animoca Brands (a gaming and venture capital company with blockchain and cryptocurrency investments – bringing the technical expertise) was forming a joint venture with Planet Hollywood (an international restaurant chain which would bring in content from the large collection of film memorabilia it owns) to build “MetaHollywood”.
According to the press release:
MetaHollywood will build the largest online community for movie lovers, studios and creators to interact within a Hollywood-themed metaverse and marketplace for digital collectibles, moments, events and experiences powered by blockchain technology and the joint venture’s native utility token.
A trust, in a business context, is a legal relationship where the ownership of business assets are held by a “trustee” on behalf of “beneficiaries”. If used effectively, it is a legal mechanism to separate legal ownership of the business and business assets from the economic benefit of the operation of the business. Although a trust is not a separate legal entity, the legal liability for the business falls on the trustee and not on the beneficiaries. For liability reasons, a trust is often combined with a private company (see below) to act as the corporate trustee (providing limited liability). Trust can be expressly made but can also be implied by law.
The key advantage of the trust structure is the segmentation of trust and personal property.
The key disadvantage is that it is legally complex to establish and administer, and costly because professional legal or accounting advice is usually required.
A company (or corporation) is a legal entity that is separate from its shareholders, officers (e.g. directors) and employees. The company is the predominant form of business structure. Companies are required to be registered or incorporated under the laws of a particular jurisdiction:
- In Australia under the Corporations Act 2001
- In Singapore under the Companies Act 1967
- In the United Kingdom under the Companies Act 2006
- In the United States under individual state corporations laws
A company is the legal owner of the business and the business assets — not the directors or shareholders. In practical terms, a company must have its own bank account and employees are employed by the company rather than by directors. In a sale of business context, separate ownership enables either the assets to be sold or shares to be sold.
There is no single type of company structure but there are four common benefits:
- Most corporate structures offer “limited liability”. That is, the liability of shareholders for the debts of the company are limited to the amount unpaid (if any) on the shares issued to them. This means that, as a shareholder, if the business fails you might lose the amount that you agree to invest in the company. However you will not be liable for any more than that.
- All companies have what is known as “perpetual succession”. That is, even if the directors of the company change, or the shareholders of the company change, the legal entity continues until the company is wound up.
- Most companies can raise capital by issuing shares. This allows founders of the company to dilute ownership (for partial exit or to fund expansion rather than debt) and allows shareholders with an easier way to sell their interest in the company (as compared with partnership or sole trader, above). Most jurisdictions distinguish between private companies and public companies. Public companies have greater access to capital markets (i.e. public offers of shares, listing on stock markets) but this comes with greater compliance and disclosure obligations.
- Most jurisdictions have a different (and lower) rate of corporate taxation.
The key disadvantages of the corporate entity are:
- The cost of registering and administering a company (most jurisdictions charge an establishment fee and yearly renewal fees)
- Directors of companies have legal obligations to the company, which is a legal risk for those individuals
- Founders may lose control of the business if shares are issued to other entities (such as VC or private equity investors)
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