Starting A Business In a Recession…
It is often said that a recession is the best time to start a business. Well-known companies such as General Electric, Hewlett Packard, CNN, FedEx, Burger King and Hyatt Hotels all began in times of recession…
STARTING A BUSINESS IN A RECESSION
It is often said that a recession is the best time to start a business. Well-known companies such as General Electric, Hewlett Packard, CNN, FedEx, Burger King and Hyatt Hotels all began in times of recession and all of have gone on to become multi-billion dollar corporations. There are some obvious advantages to starting a business during a recession. For example, office rents are cheaper, it is easier to recruit qualified people at more competitive salaries and other items such as equipment and advertising can be easily obtained at comparatively low prices. There may also be good PR in showing that you are going against the trend.
Despite the current position Ireland finds itself in, resourceful and entrepreneurial people and organisations continue to take calculated risks and launch businesses. In the first half of 2011, over 7,000 new companies have been incorporated in Ireland. This continues the trend seen in 2010 when over 14,000 new companies were set up. This was more than nine times the number of companies that were declared insolvent during the course of 2010 (1,500 companies).
Once the decision has been made to start a business, very early consideration should be given to the legal form that the business will take. Some of the most popular forms available in Ireland include:
A ‘sole trader’ is where an individual person engages in business on his or her own account. It is easier to set up business as a sole trader than to incorporate a company in terms of the administrative hurdles to overcome. However, if the business fails, the individual can be sued in his or her own name and the individual’s personal assets or property can be taken to pay the creditors of the business. Creditors can bring bankruptcy proceedings against a sole trader where the creditor is owed money and the sole trader is unable to pay the debt.
If a sole trader wishes to trade using a business name (as opposed to their own personal name) they must register that business name with the Companies Registration Office (“CRO”).
A partnership is deemed to arise when two or more people (up to a maximum of twenty) carry on a business venture with a view to making a profit, without having formed a company. Where such a relationship is deemed to exist, it will be governed by the Partnership Act, 1890 (the “1890 Act”) unless a formal partnership agreement has been drawn up and agreed between the parties. Accordingly, the 1890 Act is commonly viewed as a ‘default’ partnership agreement. Many of the terms of the 1890 Act may not be appropriate for most modern day partnerships and so for that reason parties should give consideration to putting a written partnership agreement in place.
For example, under the 1890 Act, there is no right to expel a partner; any one partner can dissolve the partnership or have it wound up by giving notice (even if there are 19 other partners involved); the partnership will automatically dissolve upon the death of one of the partners; and there is no general power to retire under partnership law.
The 1890 Act further provides that the default position in relation to the sharing of profits of a partnership is that all profits must be shared equally between the parties – even in cases where the partners have contributed different amounts of start-up capital.
A partnership does not have a separate legal personality distinct from its partners and cannot own property in its own name. Instead, all property will be owned by the partners personally. A further consequence of a partnership not having a separate legal personality is that all partners are jointly liable for the contractual obligations of the partnership. They are also jointly and severally liable for any tortious acts of the partnership. This, however, may be subject to certain exceptions in the case of a limited partnership established under the Limited Partnership Act, 1907.
There are certain advantages to carrying on business through a partnership. For example, there is no requirement to file accounts with the CRO, there are no shareholders to protect and the concept of ultra vires does not apply. In addition, the profits of a partnership are only subject to income tax at partner level. This is compared to the ‘double’ taxation of profits in the case of a limited liability company (i.e. corporation tax is paid on company profits before any dividends have been paid to the shareholders at which time income tax is paid by the shareholders).
While partnerships do not have to go through any registration process to be formed, as with the case of a sole trader, if the partnership wishes to carry on business under a name which does not consist solely of the surnames of all the partners, then the firm must register this business name with the CRO.
Limited Liability Partnership
Under the Limited Partnerships Act 1907, it is possible to establish a limited partnership (provided certain conditions are met) whereby one of the partners shall have limited liability. Accordingly, that partner’s liability in relation to the debts of the company will be capped at the amount contributed by him to the partnership. However, in order for that partner to maintain their limited liability status, they must not play any role in the management of the partnership. If that partner does play a role in the management of the partnership he/she shall become liable for all of the debts and obligations of the firm.
Limited Liability Company
The most common vehicle used to carry on business in Ireland is the private limited company established under the Companies Acts, 1963-2009 (the “Companies Acts”).
Unlike a partnership, a private limited company benefits from having a separate legal personality. This means that once a company has been incorporated, it will be viewed as a separate and distinct entity from its owners and will be seen as a legal person in its own right (subject to certain exceptions) and may, for example own property in its own name.
A company is liable for its own debts and may be sued by its creditors. It may also, itself in its own name, sue its debtors.
A private limited company may have up to 99 members all of whom will have limited liability. Accordingly, their liability to creditors is limited to the full amount payable on their shares. This will vary from company to company. While limited liability is likely to be a key motivating factor as to why most businesses choose to incorporate, it is worth noting that despite the company having limited liability, it is common for banks to seek personal guarantees from the directors and promoters of new (and well established) companies which may expose those individuals to personal liability. Similarly, where a company is seeking investment from a third party, that third party may require certain warranties from the people behind the company. In most cases, this will be the existing shareholders. The giving of such warranties may potentially expose those shareholders to significant personal liability in some circumstances.
A company enjoys perpetual succession and, unlike a partnership, will not be dissolved as a result of the death of any (or even all) of its members. A company will only be dissolved by way of voluntary liquidation, compulsory liquidation or by being struck off the CRO register.
Unlike sole traders and partnerships however, every limited company is required to file certain financial statements with the CRO on an annual basis. These statements will be a matter of public record and can be viewed by anyone upon the payment of a small fee. This is compared to the position of a sole trade or partnership who both must only file their financial records with the Revenue Commissioners. Once filed, such records are not available for public inspection.
Public Limited Company or “PLC”
A PLC must have a minimum of seven members, all of whom will have their liability capped at the amount, if any, unpaid on their shares. There is no upper limit on the number of shareholders in a PLC. A PLC is most common where a company intends to seek a listing on a Stock Exchange. The PLC must have a nominal share capital of at least €38,092, at least 25% of which must be fully paid up before the company commences business or exercises any borrowing powers.
INCORPORATION OF A LIMITED LIABILITY COMPANY
In Ireland, one of the most popular ways to commence business is through a limited liability company. In order to incorporate a limited liability company certain documents must be lodged with the CRO. These include the memorandum of association, the articles of association and the CRO company registration form. These must be accompanied by the required CRO registration fee. The memorandum of association must set out the purposes for which the company is being established, and the articles of association must determine how the business of the company will be carried on.
Once the company has been registered in the CRO, a certificate of incorporation will be issued and the company will be free to carry out all acts permitted by the Companies Acts and its memorandum and articles of association. Where the promoters of a company have purported to enter into a contract prior to the company’s incorporation the Companies Acts enable the company to ratify the contract and assume responsibility for it. Failure on the part of the company to ratify the pre-incorporation contract will mean that the promoters will be personally liable for it and the company will not be bound.
Once a company has been incorporated the Companies Acts dictate that it must fulfil certain requirements. These include requirements to:
Keep certain statutory books (such as the register of members, register of directors and secretaries, register of interests);
Keep filings up to date in the CRO;
Have a company seal which must be used by the company when executing documents;
Hold an annual general meeting of its shareholders within the timeframe set out in the Companies Acts;
Keep minutes of proceedings at general meetings of the company and meetings of its directors;
Have a nameplate affixed outside every office or place where the company carries on business; and
Have specific information in relation to the company included on the company’s letterhead.
Unlike partnerships and sole traders, companies are subject to the doctrine of ‘ultra vires’. This means that any activity or contract entered into by a company will be void unless it falls within the list of objects for which the company was established as included in the company’s memorandum of association. Accordingly, when establishing a company, it is important for the founders to ensure that the objects clause contained in the memorandum of association is comprehensive and includes all possible activities the company may engage in.
A further consideration when establishing a company is whether or not it is appropriate for the members to enter a shareholder agreement. Such an agreement deals with the day to day management of the company and may also, in most cases, deal with the exit of the shareholders from the company, dictate how shares can be transferred to third parties and provide mechanisms for the resolution of disputes between the shareholders.
While the articles of association also stipulate rules as to how the company is run, a shareholders’ agreement will generally remain a private document as it does not have to be lodged in the CRO and can therefore provide a higher degree of confidentiality in relation to a company’s internal affairs.
A potential benefit of having a carefully prepared shareholders agreement in place at the outset is that it allows the parties to have a properly defined structure and mechanisms in place to deal with difficult issues such as the death of one of the shareholders, transfer of shares to other family members, conflicts between family members or matrimonial difficulties.
Starting a new business can be risky, even at the best of times. It can also, however, be lucrative and rewarding when it works well.
When someone decides to establish a business, it is important that they take the appropriate legal, tax and other professional advice as to what is the most appropriate vehicle for that person to carry on business and how best to protect themselves if things do not work out as planned.
Where someone decides to set up in partnership with other people, serious consideration should be given to having an explicit written partnership agreement prepared to govern the specific obligations, entitlements, responsibilities and authorities of each partner.
Equally, where a limited liability company is set up, the parties should bear in mind the additional administrative and reporting requirements that come with having limited liability status.
In any event, where two or more people decide to establish a business together, they should be clear as to how the relationship can be ended. While everyone may have the best of intentions at the outset, things can, and often do, change.