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To be or not to be? An Introduction to Companies

Feb 2021

Companies are Australia’s most common business structure, making up nearly 40% of all businesses. But what is it about them that proves so popular? This article sets out some of the advantages (and disadvantages) of the company structure, the difference between a proprietary and public company, and some of the compliance obligations to keep in mind when deciding whether a company is right for you.

What is a company?

• A company is an association of people for a common object, usually a view to profit, that has its own artificial legal personality. This means it can sue and be sued, be taxed, own property, and enter into contractual relationships, all in its own right.
• Those who invest in companies own shares in the company’s capital as opposed to holding an interest in the property of the entity directly. Critically, the shareholder’s liability is limited to the face value of the shares acquired.
• Control of a company usually sits with its board of directors, or in the case of many smaller companies, a sole director. However, particular powers are often reserved to shareholders in a company’s constitution or a shareholders’ agreement.
• Companies act through their authorised representatives, including directors, who have the authority to bind the company to contracts and enter transactions on behalf of the company.

Key Characteristics

Limited liability

One of the defining advantages of the corporate form is limited liability. This means that shareholders in companies are liable to the company only to the face value of the share, not for the underlying liabilities of the company itself. This encourages investment (and therefore business activity) by enabling investors to make clear judgements about risk and value, rather than exposing investors and their personal assets to direct risk. In exceptional cases of fraud or where the company itself is considered a “sham”, courts have been willing to look past the “corporate veil” that otherwise protects shareholders, but this is the exception rather than the rule and is one of the major reasons why corporations are such an attractive form of investment.

Flexibility of ownership interests

The nature of shares as a unit of ownership is another substantial advantage. Shares are capable of being subdivided into whatever proportion may be required, and are capable of being sold (subject to the constitution and any shareholders’ agreements) in any number, whether privately, or in the case of listed companies, on an exchange, without the ownership of underlying assets changing hands. Naturally, this investment liquidity can be a huge advantage for investors – subject to the availability of a market for the shares!

Succession

Another characteristic of corporate legal personality is its perpetuity – that is, unless they are wound up, companies exist permanently. Whilst a change in partners might create a new partnership, or trusts may be inadvertently ‘resettled’ when the beneficiaries change, company directors can be changed without altering or eradicating the company identity. This allows companies to continue operating despite a lack of constancy in shareholders, and even past the lifespan of its initial directors.

Licensing requirements

The company structure is also mandated for operating certain types of business. To receive an Australian Credit Licence or an Australian Financial Services Licence, applicants must hold an ACN, which is only issued to registered companies.

Administrative cost and regulatory burdens

The advantages of limited liability and separate legal personality inherent in the corporate form are counterbalanced somewhat by the relatively high administrative burden and a strict regulatory environment. This means relatively high ongoing compliance costs and responsibilities in relation to auditing and record keeping, and increasingly, the burden of corporate social responsibility, both regulated formally, such as whistleblower responsibilities, and informally, by way of the management of public perception and reputation, especially for larger private and public companies.
Further costs are also associated with creating the documents needed to establish many companies, including the company constitution, shareholders agreements, and a range of compliance and governance policies that might support the workings of the board and the company more broadly

Proprietary and Public companies

Although there are many types of company, the two most common are proprietary limited and public. Proprietary limited companies (also called private limited companies both colloquially and formally in some other jurisdictions) are often styled as “Pty Ltd”, and have at least one, but no more than 50, shareholders. This places some restrictions on the size of the company itself, but with a commensurately lower compliance burden.
By contrast, public companies can issue shares directly to the public and have no limit on the number of shareholders they may have. To facilitate sale to the public, many public entities list their shares on stock exchanges (the principal exchange in Australia being the ASX), where the exchange maintains and regulates the complexities of the shareholders’ register, notifications, and announcements to the market. Although this can be a great way to raise capital and raise the public profile of the business, it comes with a substantial additional layer of regulation and public scrutiny, and is likely to increase the power of the board, where in closely held companies shareholders are much more likely to retain power. There is also significant valuation risk in listing, as the open market may not value aspects of the company which are prized by private investors.

Conclusion

The corporation is a structure with a huge number of advantages and few limitations, and this basic form has, over the last 200 years, become the backbone of economic activity around the world. They are versatile, well understood around the world, and extremely flexible. Their business structures protect investors through limited liability, whilst permitting the board bespoke powers to run the business as needed. Whilst these advantages are somewhat dampened by the administrative cost of establishing and maintaining corporate governance, it is unlikely that corporations will be dethroned as Australia’s most popular form of business structure any time soon. For advice tailored to your business plans on whether a company is best suited for your vision, get in touch with the team at Hazelbrook Legal.

Material in this article is available for information purposes only and is a high-level summary of the subject matter. It is not, and is not intended to be, legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this article. This article is copyright. For permission to reproduce this article please email Hazelbrook Legal: enquiry@hazelbrooklegal.com

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