Answer guides – Chapter 10 Business Organisations

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Exercise 10.11
(a) Alf is retrenched and going into the lawn mowing business.
(b) Later, Ben and Carrie consider joining Alf in business.

In (a) Alf is asking our advice about an appropriate business structure. We

have a number of facts about his business aims, his assets and the income
situation to take into account. We will tell Alf (A) what the options are, any
requirements for each option, and any relevant advantages and
disadvantages we see for him.

A’s aims – earn a little income ($30k max), and, keep fit.
It sounds like A may have a redundancy payout or at least savings, which is
why he has set a $30k limit on the income. We will need to ask A about
assets and consider steps to protecting his savings and assets.

If A has already started mowing lawns then he will be a sole trader. No

registration or formalities required. Simply start doing business on your own,
without putting the business in some other business structure, and you eill
automatically be a sole trader.

A bears sole responsibility for the business and since there is no limit to the
liability A has unlimited personal liability for the debts of the business. This
carries the risk of personal bankruptcy if A cannot pay the debts, and of
course the loss of A’s personal assets.

A would receive all the profits from the lawn mowing business. We don’t
know the detailed facts, but it seems like A only wants a modest income from
the lawn mowing business. We would want to know his other income and
other aspects about his tax position as any income will be A’s personal
income and taxed at his highest marginal personal tax rate.

A thinks the lawn mowing business will help him keep fit, indicating that
building the business is not a key motivation. A may not want to develop or
build the business, or spend much time on office or management type work.
This is a factor in recommending a business structure as other business
structures generally require more paperwork and management
responsibilities, such as ASIC returns and directors duties.
A can convert to a company structure even though he is the only person in
the business, as he can register a sole director, sole member company.

A company would give A the benefit of limited liability for the company’s
debts, and allow him to stay as a one person business, or expand by taking
on other directors and shareholders in the future if he chose.

The company would be a separate legal entity and have the powers of an
individual (enter contracts, own assets etc) and of a body corporate (issue
shares etc), s 124 CA. A would have only limited liability for the company’s
debts, up to his unpaid shares. Liability risk involves considering business
risks around revenue and profitability, and risks inherent in the nature of the
business activities. What could go wrong in a lawn mowing business?? Car
accident driving to jobs, …… perhaps run over a customer’s toes etc etc.
Assess the risk and whether quarantining that risk in a company structure
should be a major factor in the decision about business structure.

If A registered a company, the company has an unlimited life (perpetual

succession) and will exist until it is deregistered. This would give A something
that was possibly more saleable in the future than a business as a sole
trader. Compared with other business structures, the owners of a company
can easily transfer their ownership interest by selling their shares in the
company to other investors. A could decide to sell part of the company (and
retain some shares), or issue new shares to a new incoming person.

If income rises above the $30k A is aiming for, tax rates will be lower in a
company (although remember that when the co pays $$ to employees or
shareholders that $$ is taxable in the receiver’s hands).

There a more costs in running a company as there are annual ASIC fees,
and the costs of doing a company financial and tax return (cost depends on
complexity and may not be high).

Alf (A) could bring Ben (B) and Connie (C) into the business in a number of
ways. The facts tell us they are not located in the same geographic area.
Also, that B and C have recently been retrenched. We would ask A if B and C
have retrenchment packages as that raises the issue if whether A can ‘sell’
them part of the business, whether shares in a company structure, equity
contribution to a partnership, or perhaps A could even structure a franchise
operation (each of A, B, and C have their own geographic territory). A
franchise would usually be structured using a ‘head office’ company, and
companies for each individual franchise territory.
Partnership is the simplest structure and it also suits the fac\t that they all
bring different skills. They all simply start working together on the business
and sharing the partnership profits. The definition of a partnership is a
relationship or association between two or more entities, carrying on a
business in common with a view to making a profit. We would advise A to
have a formal partnership agreement though to set out the rights and
responsibilities of the partners, including profit share, role in management
decisions etc.

The main disadvantage of a partnership is the personal liability, which

includes debts and liabilities incurred by the other partners. Each partner in a
partnership is personally liable for all the debts of the partnership, even if they
are caused by decisions or acts by other partners.

The partnership ceases to exist any partners change (come into or exist the
partnership) unless the partnership agreement sets other rules. It is not a
separate legal entity so is based on the individuals. It can be harder to
manage disputes given that all three partners have partnership rights of
management and there is no simple means for a partner to sell their
partnership. The other consequence is that tax on partnership profits is
payable by each partner at their top personal marginal rate.

A company structure would allow the three to join forces, manage personal
liability, and clearly delineate who has what decision making power.

As a separate legal entity, the company has the powers of an individual and it
can therefore enter into contracts, sue and be sued in its own name (r/t the
names of each of the three people).

Another advantage of the corporate form is that a company has an indefinite

life. Once registered a company will exist until it is deregistered. Partioes can
sell their shares, the constitution can have rules about who gets first option to
buy the shares etc etc. Compared with other business structures, the owners
of a company can easily transfer their ownership interest by selling their
shares in the company to other investors.

There would be more management and paper work, and associated costs,
however the three people could be allocated work similarly to employees.

Exercise 10.12 - the kindergarten committee members – kindergarten is an

unincorporated association.
Committee members of an unincorporated association have personal liability.
The plaintiffs would sue the individual members.

This is because kindergarten is not incorporated and so is not a separate

legal entity (no registration as a company, no creation of a separate legal
entity). This means that its members can sue, and be sued in their own
names. In some circumstances, the court would rule that the management
committee is carrying out the operations and are personally liable: Bradley
Egg Farm Ltd v Clifford.

The association could be incorporated and would then have its own legal
identity and conduct the kindergarten in its own name. Members running the
incorporated association do not have personal liability then as parties bring
their legal action against the incorporated association, not the members.

Exercise 10.13 - the computer programmers and their online encyclopaedia

for the common good of members. What options are available to the group?

The group is operating but has no separate legal structure (no separate legal
entity) and so the group operates as an unincorporated association. Note this
group do not meet the definition of partnership because they are not
conducting a business for profit ($5 fee is not aimed at generating business
profits). Because the association is not incorporated individual members
running the risk of being personally liable. An incorporated association can be
formed to conduct options.

Options for the future business structure

Company
Company: As a separate legal entity, a company has the powers of an
individual and it can therefore enter into contracts, sue and be sued in its own
name. Furthermore, the owners of most companies have only limited liability
for the company’s debts. Another advantage of the corporate form is that a
company has an indefinite life. Once registered a company will exist until it is
deregistered. Companies limited by guarantee — a company limited by
guarantee involves the members of the company undertaking to contribute
specific amounts to the company in the event the company is wound up. This
structure is often used for clubs and charities.

Incorporated association
An incorporated association is a separate legal entity registered under the
relevant State or Territory legislation and is subject to a degree of regulation.
One of the main reasons for a not‐for‐profit organisation to become an
incorporated association is to limit the liability of its members.
Cooperative Cooperatives range from not-for-profit organisations to
substantial commercial trading enterprises. In all cooperatives, members’ fees
form their initial capital contribution to the business. Each member of a
cooperative has an equal share and one vote, and the members can make
joint decisions towards the running of the business. Cooperatives are
incorporated to provide members with limited liability. Cooperative is a
separate legal entity registered under the relevant State or Territory
legislation.

Digital cooperatives are typical of the sharing economy. They are cooperative
digital platforms or networks that encompass all those cooperatively owned
technologies that enable their constituent communities to create, contribute to
and use their online networks. Often little attention is paid to appropriate legal
structures at the outset. As with many cooperatives, digital cooperatives
seldom set out to become cooperatives in a legal sense, and many digital
trading cooperatives are unincorporated. It is only once people recognise the
digital technology as having a commercial value that contests for ownership or
control, and concerns about the distribution of investment returns and risks,
arise.

Exercise 10.14 – Dr Abbey and tax minimization

A key factor in minimising tax for Dr Abby is the ability to distribute the income
from her medical practice to other members of her family who do not earn an
income so as to take advantage of personal tax free thresholds and lower
personal marginal tax rates (taking into account limits of tax benefits on
distributions to children). A trading trust would provide this mechanism for Dr
A who seems to be a sole trader. This is a common structure for people in
professional practice. A trust is a creation of equity and involves one person
(the trustee) holding property (the trust property) for the benefit of another
person or persons (the beneficiary or beneficiaries).

A trust requires some formality to establish. The settlor is the person who
‘creates’ the trust (settles a nominal amount of $$, traditionally $10) on the
trust. Once established, the trust fund can be increased or decreased during
the life of the trust, provided there is sufficient capital in the trust to cover any
capital distributions to beneficiaries, and subject to the rules set out in the
trust deed. Once the trust the trust is established, the settlor is no longer
involved in the trust.

The trustee is the legal owner of the trust property and has legal authority to
administer that property. The trustee has been entrusted to deal with the trust
property for the benefit of others. The trustee is subject to fiduciary and
statutory duties. For example, the trustee must ensure that the terms of the
trust are carried out, that they deal prudently with the trust property, and that
they make appropriate distributions to beneficiaries. If Dr A wanted to have
the power to distribute the income then she could write a trust deed that
appoints her a s the sole trustee and gives her sole discretion as to
distributions.
The beneficiary is a person on whose behalf, and for whose benefit, the trust
property is held. Beneficiaries have a beneficial interest in the trust property.
The amounts that each beneficiary receives by way of income or capital under
the trust are determined by the terms of the trust, which are generally set out
in the trust deed.
The main reasons for using trusts are for taxation purposes, asset protection,
and superannuation.

Exercise 10.15 – Structure for the wedding cake business

What structure would you recommend for this business and these individuals?

J and K will invest $$, participate in management, but not work in the
business day to day. L has no $ to invest, but will be the key worker in the
business. Asa has some $$ to invest, wants a steady return on investment,
and wants some say in business spending decisions.
Theoretically, the available options are a company, a partnership, possibly an
association.
It may be easier to rule out any options that do not suit the requirements.
Partnerships are designed for a group of people to join in the business work
together. Remember that limited partners cannot take any part in
management. A partnership seems unsuitable.
An association is not really suitable for a business activity, and where returns
will be paid to investors, such as Asa.
A company would suit their requirements. Investment, management, and work
can be brought in and remunerated under the different organs of the
company.
J and K could be shareholders (contribute $$) and directors (manage the
business). L could be a shareholder (shares for work, sweat equity) and a
director (manager with business expertise). L could also be an employee and
be paid wages for work baking cakes. Asa could be a shareholder with
specified dividend rights, and possibly with special voting rights on certain
business spending decisions. Or Asa could loan money to the company,
possibly with rights over certain company decisions specified in the loan
agreement.
With a potential 4 shareholders and (probably) a small business at this stage
the company would be a small pty ltd company.

10.16 Darryl and Julia are both passionate chess players. They meet for
the first time at a chess tournament. After a short discussion
about their love of chess, they decide they should open a chess
store together selling exotic chess products to other likeminded
chess fanatics. Unfortunately, neither Darryl nor Julia have any
money. Julia’s friend Otis has told Julia he has saved some
money and is looking to invest it in a business. Julia and Darryl
approach Otis and pitch their chess store idea. Otis is blown away
by the pair’s enthusiasm for the idea, and agrees to invest
$100 000. The three agree that Otis will not receive any interest on
his investment, but will get 50 per cent of the net profits generated
by the business.

Darryl is given the responsibility of finding a suitable location for

the business. He finds a store in Burleigh Heads and promptly
enters into a lease. As Julia is out of town on business, Darryl
signs the lease in his name. He then engages a firm of architects
to prepare designs for the store.

When Julia returns, she is told about the new premises and takes
her good friend Glenda to check out the store. When they enter
the store, Glenda trips over a broom that was left lying on the
floor and severely injures her leg.

Julia is horrified by the new premises. She doesn’t like the

location, it is too dark, and it is too expensive. She tells Darryl that
the whole chess store idea just won’t work, and she has no
interest in pursuing the venture any further.

(a) Who is liable for the lease obligations, the architects’ fees and
Glenda’s injuries?

Answer:
Exercise 10.16 – Liability for the lease and architect fees for the not-yet-
started chess store

There has not been any company created. Possibly the people have formed a
partnership. If so, all partners are liable.

A partnership is created when two or more people carrying on a business in

common with a view to making a profit. Each partner in a partnership is
personally liable for all the debts of the partnership, even if they are caused by
decisions or acts by other partners.

It is irrelevant that the parties have not expressly agreed to form a

partnership, or formally signed a partnership agreement, as formation of a
partnership is a matter of contract law applied to the conduct of the parties.

In practice, it is always prudent that the agreement be formalised in writing by

a competent solicitor. Writing makes the agreement clear, and helps people
remember what they agreed (!) but the partnership may also be oral as there
are no formality requirements for an express partnership agreement.

If the parties do not have a formal, written partnership agreement, or their

agreement does not cover the issue, the partnership Act of the relevant State
will set out their rights and liabilities as partners.

It looks like these 3 people are:

● Carrying on business and,
● In common with each other and,
● With a view to profit

There is a partnership, making each of them jointly and severally liable for the
business debts of the partnership, within the scope of the normal course of
the partnership business. The business debts of a partnership may arise in
contract, such as the lease, and also for other claims, such an injury claimant
such as Glenda.

Exercise 10.17 – Leroy’s catering business needs $4m capital

10.17 Leroy is considering starting a catering business. Leroy has three

children (aged three, 16 and 21) and is married to Melanie.
The proposed business will cater to high-end corporate clients
and wealthy individuals. In order to have the ability to cater events
for these clients, Leroy needs approximately $4 million of capital.
Leroy intends to invest $2 million into the enterprise from his own
 funds and get the balance from third-party sources. Leroy wants
to have his wife and children involved in the business as well.
(a) Advise Leroy.
(b) How would your advice change if Leroy said his friend
Linus owned a commercial kitchen and he wanted to invest
that asset in the business for a 25 per cent interest in the
business?

If Leroy wants to have his wife and children involved in the business his
options available are partnership, company or trust.

Partnership
This is a possibility when individuals join forces with other individuals in
business is to form a partnership, in which all partners share control. A
partnership is a relationship or association between two or more entities,
carrying on a business in common with a view to making a profit. Each partner
in a partnership is personally liable for all the debts of the partnership, even if
they are caused by decisions or acts by other partners.

Trust
A trust is a relationship or association between two or more parties, whereby
one party holds property (e.g. investments or assets) in trust for the other; that
is, they are vested with the property.
Company
As a separate legal entity, a company has the powers of an individual and it
can therefore enter into contracts, sue and be sued in its own name.
Furthermore, the owners of most companies have only limited liability for the
company’s debts. Another advantage of the corporate form is that a company
has an indefinite life. Once registered a company will exist until it is
deregistered. Compared with other business structures, the owners of a
company can easily transfer their ownership interest by selling their shares in
the company to other investors.

Fact s and issues to consider include:

● As Leroy’s children are under 18 they cannot be directors or partners.
A trust enables a legal person (adult or company) to be the trustee, but
the beneficiaries can be anyone including minors. Beneficiaries
participate in the distribution of revenue from the trust business, but
beneficiaries have no right to participate in the business itself.
● Financing – if the business needs to take on substantial debt from
third-party sources, limited liability for Leroy and his family may be
desirable, as the debts of the company belong to the company.
● Succession Planning, particularly when the children turn 18
 ● If a partnership is involved does Linus’s kitchen become partnership
property? If the business becomes a company, then the company as a
separate legal entity is able to acquire the legal title to Linus’ property
in return for an equity share, such as share capital.

There are a couple of options to bring Linus and his commercial kitchen into
the business. Linus could be a limited liability partner, contributing equity but
not participating in the business. Lin us could be a shareholder and the
kitchen could be contributed to the business in exchange for shares. They
may also consider a joint venture since Linus wants a defined portion.