Last updated: 22 January 2024
This episode is designed to help those who are not too sure what structure they are trading through.
There are lots of different structures out there through which you can run a business and I’m not going to get into all of them because you will get bored way before I finish. So in this episode I’m just going to give you the simple explanation of a company, trust, sole trader, and business name.
Company
Companies were created a long time ago for a few reasons, one of those being for risk protection. A company is an artificial person which is liable for the debts it incurs. So when a debt is incurred by a company generally only the company’s assets are at risk, not the assets of the directors and shareholders who run the company. Those people are only liable for company debts in certain circumstances. Check out the starting point episode for some of those circumstances.
There are many different types of companies from proprietary limited (Pty Ltd) companies, which are usually ones that small businesses run through, right through to public companies (Ltd/Limited) which are companies like those that have their shares traded on the Australian Stock Exchange (ASX). There are also companies limited by guarantee, or limited public companies, or a bunch of others. But the idea behind this episode is really just to make you understand that if your entity has an Australian Company Number (ACN), has directors and shareholders, and every year you have to do an annual company return and pay Australian Securities & Investments Commission (ASIC) some money to keep it registered then it’s obviously company. Most small businesses in Australia these days are run through a company.
Trusts
Trusts are perhaps one of the most confusing structures. A lot of people come to me and say their business is run by a trust and that’s what’s in financial trouble. But despite accountants and lawyers treating trusts like they are their own separate entity, trusts are actually not separate legal entities. You cannot sue a trust and a trust cannot be sued. This creates some confusion because accountants prepare financial statements and tax returns for a trust so it’s easy to believe they are real entities. However they’re not. It’s the trustee of the trust who incurs the debt, who can sue and who technically trades on the business. So when you’re talking about a trust being in financial trouble really what you’re talking about is the trustee being in financial trouble. The trustee can be an individual (you or me), or can be a company.
As I said in the starting point episode we have two different pieces of legislation in Australia that deal with insolvency . One is the Bankruptcy Act which deals with individuals. We call this personal insolvency. So if the individual was the trustee of the trust it’s the individual who would be the one that is sued and therefore you’d explore the personal insolvency options. If the trustee is a company then you would look to the Corporations Act which deals with the corporate insolvency options. So it’s very important for you to understand who is the trustee of your trust so you know who is in financial trouble.
As an example, a number of years ago I had an accountant bring their clients to me to discuss putting a trust into liquidation because the trust owed money and didn’t have any money to pay the debts. It seems that the client had a normal job but liked trading shares. However the client didn’t have enough money to trade shares on any scale so borrowed a few hundred thousand dollars from various friends and family members to trade shares. Unfortunately the share market took a bit of turn and all of the money the client had borrowed was lost. One friend in particular didn’t really care that the share market had turned and wanted their money back. As the client couldn’t pay the money back they came to me to talk about putting their trust into liquidation. As I’ve said before it’s not the trust that gets sued it’s the trustee, so I asked who the trustee was . The accountant looked at me slightly confused, said the trustee was the individual and questioned what difference that made. When I pointed out to them that it’s the trustee that gets sued everybody’s face in the room went white because the day job of the individual trustee required them not to be bankrupt. They had a licence that they would lose if they used one of the formal personal insolvency options.
Sole Trader
A sole trader is an individual who is running a business. You could be using a business name (see below) or just trading as your name. Whatever you are doing, it’s the individual sole trader who incurs debts and can be sued if they don’t pay those debts.
Business Name
A business name is just a name that you use for your business rather than using your individual name, or a company name. So for example, Smithy’s Plumbing (business name) could be owned by John Smith (individual’s name), or Plumbing Adventures Pty Ltd (company’s name). The business name is not an entity that incurs debts, it’s the owner of the business name who incurs the debts. That could be an individual as a sole trader, could be a company, or any of the tens (if not hundreds) of different structures that are available. So it’s very important for you to understand who is the owner of the business name so you know who is in financial trouble.
The legal stuff
Australian insolvency laws are complex and understanding them can be difficult. Hence this blogpost! I’m trying to simplify everything to help you make an informed decision. A decision that’s not based upon what someone said at a bbq!
Just remember that I don’t know your financial circumstances, so what’s in this blogpost is intended as general information only. Before taking any action you should seek professional advice that takes into account your individual circumstances.