Which legal entity will operate the business?
Will you trade under your personal name/s (sole trader or partnership) or form a legal entity (such as a company) that is a separate legal entity from you? There are advantages and disadvantages of each. If you are a sole trader, you are entitled to all of the profits from the business in your own name, but equally you are personally liable for any debts or liabilities the business incurs. A company is a legal entity in its own right, separate from its shareholders. Both the profits and losses belong to the company, meaning that generally (subject to personal guarantees you may have given or director’s liabilities under the Companies Act, and certain other legislation) your liability is limited to the amount you are liable to pay for your shares in the company. If you have fully paid for your shares, you will generally have no additional liability.
Who will have the ownership or other roles in the legal entity?
Who will have an ownership role in the legal entity (shareholders in a company)?, who will have the governance role (directors)? and who will work for salary or wages (employees)? It may not necessarily always be appropriate for ownership in the entity to be equal, with differing parties making differing contributions to the new entity (depending on funding, experience, equipment or other items contributed). Having these contributions valued to determine ownership levels can prevent disputes in the future.
What governance documents will be prepared?
A trust deed for a trust, a constitution for a company and a partnership agreement for a partnership are all essential documents that set out the agreements between the parties and the rules that will govern the operation of the business. In the case of a company, a shareholders’ agreement, simply and clearly written, should cover the key decision making processes (including appointment and number of directors, directors’ and shareholders’ voting rights, and quorum requirements), the ability of shareholders to sell their shares or otherwise exit the company (and whether there are any restrictions on this), and what is to happen if things go wrong between the shareholders. Documents which clearly set out the agreements between the parties minimise the potential for misunderstandings.
How will you ensure the different legal entities’ obligations are complied with?
A company is required to maintain share registers, file annual returns and reports, hold meetings of directors and shareholders including recording and keeping formal resolutions. Company directors have obligations under the Companies Act including to act in good faith and in the company’s best interests. Trustees of a trust must also hold meetings and record their decisions by resolution. Trustee decisions must be made in accordance with the trust deed and overriding trust law. All businesses will have tax and GST obligations that you will need to discuss with an accountant. Other compliance obligations will include, among the many other requirements, health and safety obligations, employment obligations, and obligations to obtain the relevant resource, building or other consents and permits to operate the business. Ensuring your business operation is legally compliant is an essential part of operating a business. Obtaining sound advice will be particularly important.
Will you be advancing funds to the business?
If so, what will the terms of that loan be and will that loan be “secured”. A loan document will record the terms of the loan. In the case of a company, security for the loan could include, for example, taking a “security interest” over the company’s property. In general terms, when a loan is secured this means that if the company is placed into liquidation, you will be a secured creditor for the funds that you have advanced to the company. Being a secured creditor means that you have priority ahead of unsecured creditors in respect of any funds available if a company is liquidated.
What insurances are appropriate?
In addition to insurances for the business (loss of profits, coverage for property and public liability) consideration should be given to insurance for directors and employees (in the event of liability claims).
What is your personal exposure involved in this business?
Even where a company is set up, as a separate legal entity, consideration should be given to potential personal exposure. Any documentation signed which includes a personal guarantee should be considered carefully and the extent of the exposure determined. Consideration should be given to whether the guarantee can be limited or deleted. Overriding legal obligations could impose personal liability where those obligations are not complied with (for example, if directors of a company engage in reckless trading). There are options available to minimise the impact of claims from creditors against your personal assets, including for example, where personal assets are owned by a trust (although there are important limits to how effective this can be).
These are just some of the examples of the various matters you need to consider before starting a business. There are many more, such as the many tax, GST and accounting decisions that you should discuss with your accountant.
During the initial stages of starting a new business, and when all parties are in agreement as to the business itself, future disputes may seem unlikely. Unfortunately, disagreements do happen and can be stressful, time consuming and costly to resolve. Obtaining legal advice before set up is essential to minimise the possibility of such disagreements and maximise your chances of business success.
This article is current as at the date of publication and is only intended to provide general comments about the law. Harkness Henry accepts no responsibility for reliance by any person or organisation on the content of the article. Please contact the author of the article if you require specific advice about how the law applies to you.