Question

Gary Reynolds is a sole trader and runs his own business as an architect. Gary tried to expand the business 12 months ago by borrowing $100,000 from Rap Bank, employing two assistant architects and setting up a new office on Mitchell Street, Darwin. Gary now finds that his operational costs and debts are much higher than the revenue coming in from the architecture services he provides. A number of creditors are now pressing Gary for payment, including the landlord who wants to repossess the Mitchell St office because of unpaid rent. These creditors cannot all be paid within contractual terms. Gary, a single father, owns a house which is mortgaged to Rap Bank and various other assets such as two cars and some cash in his bank account. Explain how Gary’s situation might be different if he was a director of a company (eg, ‘GR Architecture Pty Ltd’), instead of being a sole trader. Describe the advantages and disadvantages of establishing a company?

Answer 1

Since Gary Reymonds is a sole trader running the business as an architect, the concept of legal separate entity do not apply here. Meaning thereby Mr Gary Reymonds and his sole proprietory business are not a seaparte entity in the eye of law rather shall be treated as a single Person.

Due to this reason the liability of a sole trader is unlimited. On the occasion of any loss in the business, not only the business assets, but also the private assets of the sole trader (house, cars etc.) can be sold for recovery of losses.

So in the present case since there is a pending liability of following :

1.) $100000 borrowed 12 months back

2.) Salary of 2 assistant architects

3.) Pending dues of Creditors

4.) Pending dues of Rent

Now since it it mentioned in the question that the creditors cannot all be paid within contractual terms so he has to used his personal assets in order to pay to these creditors and any other liability if any.

The situation would be complety different if was a director of the company. In that case he did not required to liquidate his personal assets in order to the liabilities of the company. This is again because of the concept of legal separate entity. The company is a separate legal entity having its own distinct entity in the eye of law. And it is a different person in the eye of law as company as company to its directors.

Advantages of Company:

Limited Liability

Perpetual Existence

Professional Management

Transferability of Shares

Diffusion of Risk

Expansion Potential

Availability of more funds

Disadvantages of Company:

Lack of Secrecy

Restrictions

Lack of Personal Interest

Management Mischief’s