The law relating to companies is extensive (there are many books on the subject) which is why this post is longer than my usual. So grab a cup of coffee and come over into my world of company law.
I’ve mentioned that being a sole trader or a partner in a partnership means that there is no legal separation between you and your business. This changes when you create a company as the company is a formal legal entity, separate from its owners (the shareholders) and those who govern the company (the directors). A company has many of the same rights as a natural person; it can enter into contracts and it can buy land.
Once you have incorporated a company it’s important to know which hat you are wearing when you make decisions; are you an employee, a shareholder or a director?
Limited Liability. Your personal liability is limited to the money you invest in the company as a shareholder. If the company fails, your personal assets will normally stay out of reach of creditors of the company. The main exception to this is where you provide a personal guarantee for a debt or a loan of the company. That debtor will be able to seek to claim your personal assets to repay the guaranteed debt. Banks, in particular, tend to ask for personal guarantees from directors or shareholders of small companies. You should think carefully and seek advice about the implications of signing such a guarantee before doing so.
Tax Rates. Companies pay tax on profits at the corporate tax rate which is often lower than personal tax rates. Be aware that the lower tax rate is only relevant to profits retained by the company. Profits that are distributed to shareholders (i.e. dividends) are taxed at the dividend tax rate that is applicable to the shareholder. Certain tax credits are available to shareholders for that part of the tax that the company has already paid on its profits so the dividends aren’t taxed twice.
Substantial Legislation. Both NZ and the UK have Companies Acts which provide a comprehensive and effective default set of rules governing the relationship between shareholder and directors, and between shareholders. Unless the shareholders wish to amend these rules to reflect something different in their business, the rules can usually be relied on.
Sale Time. Conducting your business through a company makes it easier to sell your business, or a percentage of your business, by selling all or part of the shares in the company.
Increased Administration. One disadvantage of a conducting business through a company as the formal and administrative requirements that need to be complied with.
Directors’ Obligations. There are strict obligations placed on directors to act in the best interests of the company. For example, you need to be aware of:
- the “major transaction” rules in NZ or “substantial property” transactions in the UK
- registers of directors, directors’ interests and shareholders that need to be kept
- the legal methods and formalities you need to follow to receive money from the company.
Shareholders’ Agreements. If you have multiple shareholders and want to supplement the default rules in the Companies Act you will need a shareholders agreement to be drafted and negotiated.
If you incorporated your business as a company, then your company has a “separate legal identity”. This means that the company is treated by the law as if it is a “person”.
Even if you own all of the shares of your company:
- you are still employed by your company or a contractor to your company
- the company (not you!) is the “person” who enters into contracts
- Any money in the bank account of the company belongs to the company.
Owning the shares of a company doesn’t mean you can do whatever you want with the company and its assets. It only means you get to make certain decisions for the company, as well as having the right to get any dividends distributed by the company and any money left over when it eventually ceases to exist.
These distinctions might seem pedantic but they are very important. You need to always respect the separate legal identity of your company and need to know about, and comply with the relevant laws. If you don’t then the courts can do what is known as “piercing the corporate veil”, which means that the limited liability of the company can be removed and direct access can be gained to you and your personal assets.
You are not alone
If you’ve never considered any of these matters and have never had a problem, you’re not alone. From what I have seen many companies and their owners don’t follow the rules properly. While this can be unlawful, it may not be picked up – until something happens. For example, your company might get investigated by the taxation authority, you might decide to sell your company and it is discovered that you haven’t kept the correct records or you might have a disagreement between the shareholders of the company.
In all these cases, if your company isn’t legally compliant you are taking a serious risk. Penalties range from a fine to imprisonment for very serious breaches. In some cases directors might also have to pay back money they received from the company!
I would highly recommend that you start as you mean to continue, taking the establishment and maintenance of your company seriously.
In both NZ and the UK the incorporation process is relatively simple and can be done online. At the time of writing, the cost to incorporate a new company in NZ was $160 and in the UK was £15.
Alternatively, you can pay a lawyer/accountant/formation agent to incorporate a company for you (market rates vary but a ball park in NZ is around $500 and in UK around £150).
Although we all like to save money please make sure you are not being cheap. While the mechanics of filling in the forms and filing them can easily be done by you it is what comes next that can create problems for you as I mentioned above.
Do you know what your duties as a director are? Do you know what registers and records that your company needs to keep and for how long? Do you know what needs to be filed and when? Have you read the constitution that your company adopted when it was formed? Did you realise that you’d adopted one?! Do you know if that constitution is right for your company and its shareholders (this is especially true if you have more than 1 shareholder)?
These questions can be discussed with your lawyer so that you know that you’ve formed your company in the right way and are fully aware of the obligations going forward.
Grab your free copy of the Legal Health Workbook, designed to help you get clear on the legals you need in business, so you can begin to create a solid business foundation – and never have another sleepless night wondering if your legal ducks are in a row.
Disclaimer: This article is an educational resource designed to make you aware of some of the legal needs of your business. The information provided should be treated as a guide only and should not take the place of hiring a lawyer. Reading this article does not create a lawyer-client relationship between us. If you have a specific legal issue you need help with, you need to hire a lawyer.