Week 1. How To Identify Your Business Structure

*Please note this is a general guide only and should not be used in place of obtaining our advice.

The excitement of setting up a business (such as a start-up) can often lead to confusion for many reasons. You may have a great idea and have started getting a team together, but have you thought about the best legal structure for you? What about protecting your idea and putting contracts in place? Taking the time to think about these things now can save you a lot of money, time and pain in the long run.

We know you don’t have much time, so to make it easy for you we have put together a list of things that are essential to consider from the outset, so that your business or start-up is on the right track from the start.

Getting the right structure for your business from the outset will help you avoid headaches later down the track, and improves the odds of your business being a success.

Business structures can be broken down into 4 key categories: Company, Trust, Partnership and Sole Trader.

Company

There are many benefits to using a company to conduct your business. The company tax rate is lower than the highest individual tax rate, so your profits may be taxed at a lower rate than if you weren’t using a company.

Companies also provide a high level of protection for shareholders – you’ve probably seen the letters “Ltd” or “Limited” at the end of a company name before? This means that liability of shareholders in the company is limited to the amount unpaid on their shares (which is generally a nominal amount such as $1.00). So if the company becomes insolvent (i.e. runs out of money), although the company could lose all of its assets, your personal assets (such as your home) will usually be safe.

The disadvantages of using a company are that companies are more regulated than most other business structures and annual fees are payable to the Government keep a company registered. Also, the directors of companies may be required to provide personal guarantees to lessors, suppliers and lenders to the company, which ultimately defeats the “limited liability” aspect of having a company. Giving a personal guarantee means that if the company doesn’t perform its obligations, the person who you gave the guarantee to can come after you.

Directors also have duties under the Corporations Act, and a breach of those duties could result in personal liability.

Is a Company the right structure for you?

A company is the right structure for you if you want the highest and best level of asset protection. In deciding whether to use a company, consider the activities of your business, what could go wrong and the cost of a risk eventuating.

Trust

A trust is simply a relationship where a person (“trustee”) conducts the business for the benefit of other people (the “beneficiaries”). Set up the right way, a trust can be more tax effective than a company.

A trust is also an effective way to protect a business’ assets. However, trusts are more complex than the other business structures, and setting up a trust may have high costs.

The trustee of a trust can be an individual or a company. If the trustee is an individual, they can be personally liable for the losses incurred by the trust. The benefit of having a company act as trustee is that, provided the company has no assets, the company has nothing to lose in the event it is liable for the losses of the trust. By using a company you essentially add a layer of asset protection.

There are several different types of trusts to choose from, with the most common being a discretionary (or family trust). Another popular option is a unit trust. We can discuss these options further with you.

Is a Trust the right structure for you?

We recommend you seek your accountant’s advice as to whether running your business through a trust is more tax effective than running it through a company.

If you do proceed with a trust, we generally recommend a company be established to act as the trustee so as to give you an added layer of protection.

Partnership

A partnership is an inexpensive way to set up a business with multiple co-owners (“partners”) and is established simply by all the parties signing a document (although the partnership could also be incorporated, similar to a company).

Partnerships are relatively uncommon and that is in a partnership, all partners are personally responsible for the debts of the partnership, even where only one partner incurs a debt in the name of the business. For example, if there was a partnership of two people, one partner could go and get a loan on behalf of the partnership without the other partner knowing about this. If the partnership defaults in payment of the loan, the partner who did not know about the loan is still personally liable to pay the loan.

There are ways of limiting your liability in a partnership through the use of companies and trusts, however generally if you are going to the effort of establishing a company/trust you would not do a partnership.

In a partnership, each partner’s share of profits will be taxed at their personal tax rate.

Is a Partnership the right structure for you?

Partnerships generally provide minimal asset protection and should only be used in limited cases.

Sole Trader

If you want to start your business on your own, the sole trader business structure may suit your needs. As with a partnership, a sole trader structure is inexpensive and simple to set up. This structure provides you with total control over the management of your business and has less regulation and paperwork involved compared to other business structures. Essentially all you need to do is register for an ABN and away you go!

Because you aren’t shielded by a company or other structure, the main disadvantage of this structure is that you are fully liable for all of your business’ debts. The profits of your business are also taxed at the personal tax rates, which may be higher than the company tax rate depending on how much profit your business generates.

Is a Sole Trader structure right for you?

If your business is carrying on very low risk activities and you aren’t bringing anyone else in, operating as a sole trader may be the best option for you.

What next?

Given the complexities of the different types of structures available and that there is no “one size fits all” option, it’s important you get the right legal and tax advice before starting out.

Merton Lawyers has extensive experience in working with new businesses and start ups in various. We also have great relationships with accountants who specialise in this area and would be more than happy to introduce you to our contacts if you don’t have an accountant.

Contact us on (03) 9645 9500 or email our directors Anthony Curtin at anthony.curtin@mertonlawyers.com.au or David Rennex at david.rennex@mertonlawyers.com.au to find out how we can help you.