Have you set up the right business structure?
Just like in building a house, the foundation is a key component of building a strong, long-lasting business and a fundamental element of a business’s foundation is how it will be structured. Unfortunately, what with the stress and excitement of setting up a new business, the business structure is often chosen quickly, without much thought or planning involved. This can have long-term ramifications for its success.
Which business structures are available?
Australian businesses use four basic structures:
- Sole trader: a single-person business structure where the business owner assumes sole responsibility for any issues that occur with the business. This is the simplest and cheapest business structure to set up, but all liability for debts and damages rest with the owner – they can’t be shared out. The owner pays income tax on profits received.
- Partnership: a multi-person or entity structure where profits and liabilities are shared out between all partners in the business. This is the simplest format of having multiple owners in a business. The partners pay income tax on their own share of the profits. The partnership itself is not a legal entity, and it is the partners who are effectively its legal representatives.
- Company: a company is an association of individuals or entities who share a common purpose and seek to achieve a common goal. Effectively the company is treated as a separate legal entity when it comes to contracting, reporting income and paying tax. Companies have a board of directors, who are legally responsible for the company’s decisions and who may receive wages. Generally, the directors aren’t responsible for company’s liabilities, but there are many exceptions to that.
- Trust: Is the forming of a structure around an asset to govern how the asset will be dealt with and who benefits from it. In itself, the trust is not a separate legal structure and it has a trustee (could be an individual or a company) to represent it. The trust deed governs the actions of the trustee and instructs how the profits can be distributed to beneficiaries of the trust.
What are the consequences of picking the wrong one?
Some of the consequences of a poor business structure decision are:
- Little or no protection of assets held by the individuals or the business.
- A lack of flexibility in tax planning and tax reduction strategies.
- Foregoing opportunities for exemptions from capital gains tax.
- Difficulties in changing structure to suit the business’s growth.
- Lack of flexibility to bring in new partners.
- Reduction of the sale value of the business.
- Logistical issues arising from having to shift business structures while operating.
- Issues with succession and estate planning
- Being unacceptable to licensing authorises
Choosing the Right Structure
Your advisor will consider many of the points above and many matters in relation to your personal position, your business intentions and so forth before advising you on the correct structure. Is it not easy to lay general comments on how to decide which structure is suitable, but a fact is that one of the most commonly used structures for small business is a Trust with a Corporate Trustee.
This structure has been popular because it ticks many of the boxes such as asset protection, flexibility for tax planning, benefits from small business concessions, benefits from capital gains tax exemptions etc. To note however, the cost of setting up this structure and the on-going compliance must be understood and measure before jumping into the decision.
Talk to a business advisor
Before you start building your business, talk to an advisor. They can work with you to clarify your business intentions and plans, then pinpoint the exact business structure that will work best for you. Doing this small amount of work at the very start will allow you to move forward with full confidence and peace of mind, focusing on actually building up the business.