The legal structure of a business can take a variety of forms. Deciding the appropriate business structure takes some thought and consideration as it is a decision that can impact you personally.
The most common types of legal structures are companies, companies with trusts, incorporated associations and co-operatives, sole traders, as well joint ventures and partnerships. When you are choosing a structure for your business, there are many different considerations to take into account. These include:
- your own personal liability
- asset protection strategies
- whether you will be raising capital or applying of grants
- whether you will need finance for your business
- how you want to distribute profits that you make
- whether you are looking to sell or commercialise the business or its assets
- if there are any taxation issues to consider with your accountant
- whether there are regulatory requirements for your industry
- the ongoing costs that you are comfortable with forking out moving forward.
To determine the most appropriate structure for your business, a good advisor requires a full understanding of your proposed idea and business, your future plan and goals, and your personal circumstances.
- Liability and Asset Protection
The unfortunate truth is that all business involves some level of risk. It is therefore essential to determine whether those involved in the business want a clear separation of their personal assets and liabilities from that of their business.
Not all business structures allow this kind of separation. For instance, sole traders are personally liable to meet the obligations of the business. This means that as a sole trader, your business and personal assets are one of the same thing. If your business obtains a loan or debt, then your own car or house may be used to pay off those business loans or debt. They are one of the same.
Similarly, partners in a partnership are jointly and severally liable for the performance of the obligations of the partnership. If one of your partners makes a bad business decision, then your personal assets may be on the line.
On the other hand, there are companies (also known as corporations), which are a completely separate stand-alone entity from yourself. This means there is a level of separation and asset protection. However there are some instances in which you can still be personally liable and prosecuted for acts, such as insolvent trading.
Now for the tips. To assess what business structure suits you, you must first analyse the extent of the obligations that will arise in operating your business – both in the short and long-term. For instance, will you be requiring employees, entering into a lease for a shopfront, contracting with any service providers, suppliers and clients/customers, or are you obtaining finance or looking for investors. Not to mention, what does your industry require from you and have you receive advice from your accountant about your tax obligations.
- Capital Raising
At some point, most businesses will need to raise capital. Capital raising typically involves selling a portion of the ownership of a business to current shareholders, or to third-party individuals or their companies. Some business structures are not actually suitable to meet the capital requirements by third parties, which adds to the importance of getting your business structure right first up.
Investors will usually have their own standards and requirements to evaluate a business and its obligations. For instance, investors may require you to provide your business plan, produce financial statements and demonstrate the potential of the business and idea. Generally, investors will not agree to advance any funds to a business without actually receiving in return an ownership stake in the business and management control. For a company business structure, this is usually by way of shares (including voting rights). They may even require some security over the business assets or personal guarantees from those involved.
For more information on capital raising, see our article on raising capital here.
As the story goes, there are three certainties in life: life, death and taxes. Each business structure has its own unique tax and duty implications. There are both tax and duty implications to consider on a national level, but also from a state/territory level too.
Tax considerations include how the business structure assesses income tax, capital gains tax, goods and services tax, payroll tax, fringe benefits tax, land tax, stamp duty, excise duty and other forms of fees. Duties and levies may also differ between the alternative types of business structures.
It’s critical to obtain tax advice from an accountant when you are looking to establish a business – well before you actually set it all up. An accountant can provide you with an understanding of these unique tax and duty implications and may even offer you ways to reduce or mitigate those implications.
You can also use the Australian Taxation Office’s website to help you understand the different tax obligations of business structures. [insert hyperlink]
- Management and control
The choice of business structure impacts the degree of control that founders and directors of the startup can exercise. A sole trader generally retains full control of the business.
In the case of a company, there is an appointed board of directors who control the day to day management of the company and businesses. Shareholders are the owners of the company. A shareholder’s control is how many shares they own in proportion to the number of shares held in the company. For example, in a basic company which has 120 shares and two shareholders, each shareholder has 50% control of the company. Shareholders receive rights under the company constitution and shareholders’ agreement and will have a say on the appointment of directors and some business decisions.
- Purpose of the business and distribution of profit
When starting up, it is important to consider the purpose of the business. This is usually addressed in your business planning. You should consider the distinction between profit-making ventures and non-profit ventures, as this may assist to analyse which venture to focus your efforts for the best return. Bolter believes that community giveback and sustainability are worthy ventures to consider aside from the focus on profit.
Some business structures aren’t set up to allow for a distribution of profit. In the case of a sole trader, any profit from the business goes directly to the sole trader, whereas if the business is a company, the profit will be distributed proportionately between shareholders (relative to their shareholdings). Trust structures, particularly discretionary trusts, actually allow the trustee some flexibility to allocate and distribute profit between the trust’s beneficiaries following the trust deed.
If you have taken out a business insurance policy, then your insurer may have a say in the choice of business structure. This depends on the industry you intend to operate within, but it’s always good to check with your insurer.
If your business is wishing to operate within the not-for-profit sector, then you should consider whether your business qualifies for government funding or grants, or other subsidies and tax concessions (such as deductible gift recipient (DGR) status to receive donations, or GST concessions).
- Costs of the business structure and regulatory requirements
You need to remember to factor in your ongoing costs such as annual taxation costs and business registration fees, ongoing regulatory compliance costs and other regulatory reporting costs. Generally speaking, a company structure – in particular, a public company – is far more expensive to set up, operate and maintain than other business structures, such as a sole trader or a partnership. For example, some of the ongoing requirements of a company include holding board meetings, the preparation and lodgement of financial reports and paying your annual company registration fee.
These are only a few things to think about when starting up a business. If you are already operating your business, then it is not too late to obtain some advice on how your business structure can work best for you.
Your business structure should take into account your idea and your business, your future plan and goals, and your personal circumstances. At Bolter, we take a 360-degree view of your business to ensure that we can handle your legal requirements, leaving you to push on with starting out. So, get in touch and see how we can make it happen.