Advice On Business Structure And Directors Duties For Small Business In Fashion Industry

Dear John

This is in regards to the discussion on appropriate business structure for the establishment of small business in the fashion industry.

Before proceeding to the specific advice, I would briefly like to touch on the various business structures that are possible along with their respective merits and demerits of each of these.

• Sole Trader- This is a business structure where a given person holds 100% in the business. This owner is responsible for taking the various business decisions and also is responsible for bringing in capital for the business. Also, this business structure does not have any separate legal entity, hence any business liability is essentially the liability of the owner (Gibson and Fraser, 2014).

• One of the key advantages is that the owner has full control on the business and there is no profit sharing.
• Another advantage is that the legal formalities involved in the formation of this business are minimal along with no reporting requirements.
• Besides there is no necessity to prepare financial reports and results for the business in any particular pattern since they is no other shareholder except the owner.

• The owner has to take various decisions and manage all aspects of the business which may lead to inferior business decision making especially If inferior skills are there.
• The owner has to bring in incremental capital which may be required for the business and cannot arrange the same through equity dilution.
• The owner would personally be responsible for any business liability that may arise.

• Partnership – This is a business structure where there are two or more partners who tend to have ownership in the business and are known as partners. The profits generated by the business are distributed amongst the partners as per the partnership agreement which typically outlines the profit sharing. Like sole trader business structure, a partnership is also not a separate business structure and hence business liability would fall on the partners (Davenport and Parker, 2014).

Merits of partnership

• There are more than one owners to the business and hence the underlying responsibilities related to business can be delegated amongst the partners which typically leads to superior decision making.
• Also, with regards to source of capital also, the onus would not be an a single individual but with multiple partners, raising of extra capital is easier as compared to the sole trader business structure.
• The legal formalities involved in the formation of this business structure are minimal since only a partnership agreement is required which may or may not be registered. Also, the reporting formalities on a periodic basis are absent.

Demerits of Partnership

• The partners do not have exit options as they cannot sell their stakes to others and will have no option but to dissolve the partnership firm and form a new partnership firm. This is an issue even when capital wants to be raised through share dilution.
• Also, since this business structure does not have a separate legal entity, hence the partners would be held personally liable for the business liabilities.

• Company – This may be consist of one shareholder (known as one person company) or may have multiple shareholders which varies according to the type of companies. Unlike, other business structure, the company business structure is a separate legal entity and hence owners and the company are separate (Pendleton and Vickery, 2015).

• Considering that there is separation of company and owners, hence the liability of shareholders or owners is limited to only the equity capital that they have put in.
• Raising capital is easier than in other business structures since shares can be issued to other private investors or to the public through stock exchanges.
• Also, the existing shareholders and promoters can exit the business as the shareholding of the company can change while company maintaining the legal entity.

• There is dilution of equity and also of control since there are multiple shareholders that have voting rights proportional to the shareholding.
• With regards to formation of company, there are legal hassles as a lengthy process is involved. Further, there are higher reporting requirements associated with companies which are government by Corporations Act 2001.

With regards to the key aspects of the business you intend to open, the following aspects are pivotal.

• Based on the information provided, it seems that you would be the sole owner of the business which implies that the partnership business structure is not feasible and thus the only two choices possible are company and sole trader from which a suitable choice ought to be made (Pathinayake, 2014).
• It is known that you aspire to open a small business currently and thus the capital and resource requirement would be typically small. Further, the funding requirement of the business may not be huge considering the business is not very capital intensive and the main cost would be in terms of inventory which can be managed. Thus, a sole trader seems a more viable option than a company since there are additional legal and reporting expenses associated with the company that need to be avoided at the moment. Also, the corporate tax rate of 30% may seem high at this junction when the business is just starting and through the sole trader, the applicable tax rate could be lower depending on the amount of profits.
• The nature of the business is such that the chances of being sued by the customers Is lesser than in other businesses. Also, considering that business would not be capital intensive, hence the outstanding business liabilities would not be huge. As a result, even if a sole trader business structure is chosen at this stage, it would not be cause of concern at this juncture (Lindgren, 2011).

Considering the above discussion, I would recommend that the suitable business structure that meets your current business needs is that of a sole trader. However, it is noteworthy that going ahead when the business grows in size and capital needs, then a fresh review would be required.  In case of any further queries on this matter, please feel free to contact me.

Yours Sincerely

….

Considering the pivotal role that is played by the directors, a plethora of duties have been outlined in the Corporations Act 2001 in relation to the directors. These are detailed below (Ciro and Symes, 2013).

• In accordance with s. 180, directors have a duty to care towards the shareholders and hence must discharge their duty with requisite care and diligence. This is pivotal so as to ensure that the decision making by the directors is taken with requisite reasoning and not in a reckless manner. While the decisions of the directors could eventually lead to loss but atleast they should be based on sound business judgement.
• In accordance with s. 181, directors must ensure that they fulfil their fiduciary duty of being an agent by ensuring that requisite decision and activities are driven by the objective of furthering the interest of the shareholders. This is vital for the governance of the company so as to ensure that the directors do not become self-serving and thus do not use organisation as a means of serving their own interests at the cost of shareholders’ interests (Cassidy, 2013).
• In accordance with s. 182, directors have privileged position and the same should not be used for advantage to self or others. This duty ensures that the business decisions are not driven by personal considerations and thus, organisation should be placed first with regards to priority being served. Also, it avoids instances of abuse of power which ensures better governance.
• In accordance with s. 183, directors cannot use the information gained on account of their position for personal gains or for hurting the interests of the company. This is pivotal particularly with regards to ensure that directors do not engage in any competing business with the firm’s clients. Further, this also serves the purpose of serving the interest of the company even when the director has left the organisation and has access to confidential information (Lindgren, 2011).
• In accordance with s. 184, directors must act in an honest manner with good faith. This has assumed special importance in the wake of various corporate failures witnessed in Australia where the management has not acted in a honest manner which has resulted in the firm becoming insolvent. Hence, for the corporate governance of the firm, the underlying honesty of the directors is of pivotal importance.
• In accordance with s. 191, directors must disclose any material conflict of interest that they have to other directors if such a situation does arise, This is pivotal since in the course of business, it may so happen that business has to deal with related parties of a particular director, then the presence of such a director in decision making on such a matter can result in wrong decision being made which may not be in the interest of the company. To prevent such a situation, it is necessary that in such situations, directors should disclose the same to other directors and then let them take the requisite decision (Cassidy, 2013).
• In accordance with s.588G, directors have the duty to ensure that insolvent trading is prevented by the company. This is a pivotal duty which relates to the going concern since the directors have the authority to raise incremental debt for business. Thus, the directors need to be mindful of the fact that incremental debt should not make the company insolvent and thus debt to that extent should be assumed which the company under the given financial situation can service. This also acts as a check against getting overleveraged (Pathinayake, 2014).
• In accordance with s. 286, the directors have the duty to ensure that appropriate records and books of account for the business are available which can justify the current financial position of the business. This is imperative for the governance of the firm as the performance of the firm is reflected by the books of account and hence these should be accurate so as to aid decision making by both the management and also the investors.
• The directors must also take relevant steps so as to ensure that the company is able to meet the reporting obligations which are bestowed on it on account of relevant provisions of Corporations Act 2001. This is vital as essentially the shareholders are the owners of the company and thus they need to be periodically informed about the financial performance and financial position of the business. Also, there are other stakeholders which tend to base their business with the firm based on financial statements which includes primarily lenders and creditors (Cassidy, 2013).
• The directors also have the duty to attend the board meetings and also to take active part in the same with regards to the underlying decision that is being discussed. This is imperative since important decisions regards the firm are taken in these meetings. Thus, non-participation or complete absence implies that the director is not discharging the duty towards shareholders and company which might adversely impact the firm’s performance.

On the basis of the above, it is apparent that there are multiple duties that are bestowed on directors so as to ensure that directors tend to perform their duty with diligence, honesty and driven by shareholders’ interest. These have been inserted considering the pivotal role played by the director in the governance of an organisation.

References

Cassidy, J. (2013). Corporations Law Text and Essential Cases 4^th ed. Sydney: Federation Press.

Ciro, T. and Symes, C. (2013) Corporations Law in Principle 9^th ed. Sydney: LBC Thomson Reuters

Davenport, S. & Parker, D. (2014) Business and Law in Australia 2^nd ed. Sydney: LexisNexis Publications.

Gibson, A. & Fraser, D. (2014) Business Law 8^th ed.  Sydney: Pearson Publications.

Lindgren, K.E. (2011) Vermeesch and Lindgren’s Business Law of Australia 12th ed. Sydney: LexisNexis Publications.

Pathinayake, A. (2014) Commercial and Corporations Law. 2nd ed. Sydney: Thomson-Reuters.

Pendleton, W. and Vickery, N. (2015) Australian business law:  principles and applications. 5th ed. Sydney : Pearson Publications.