Before diving into the features of each business structure, it may be worthwhile to first consider the key factors and their ramifications on your business. On the top of my list would be fund raising, control, capability, taxes and asset protection.
1. Fund raising
Obtaining outside funding sources, whether through investor or venture capital and bank loans, can be critical for businesses seeking to expand. In this regard, forming a company may offer a more effective means of securing funding for growth. Companies have the advantage of being able to issue shares and other capital and debt security instruments, which can attract investment from a wider range of sources.
In contrast, sole proprietors are typically limited to relying on personal or family resources for funding. This makes forming a company an attractive option for businesses seeking to access a more diverse range of funding sources to fuel their growth.
When considering business ownership options, it is important to understand the level of control that can be retained in each structure. Sole proprietorship and sole-trader companies offer primary control to their owners, while partnerships allow for negotiated control agreements. However, corporations are constructed with a board of directors that make major decisions, although a single person can initially control the company. As a corporation grows, it typically operates as a board-directed entity.
It’s worth noting that the extent of external funding can dilute control or voting power and management discretion. Funding arrangements may come with voting rights or minimum performance results attached, which can affect decision-making within the company. As a result, it’s important to carefully consider the potential impact of external funding on business operations and control.
If your business requires certain capabilities, such as knowledge, skills, experience and a vested business network and influence, it may be necessary to dilute control and management discretion. In exchange for their collaboration, stakeholders may be offered a stake in the business or shareholdings, as well as key position.
Individuals operating as a sole trader or partnership have their profits taxed at individual rates, which can be as high as 49% including medicare levy. In contrast, companies and trusts are taxed at lower rate of 27.5% during the 2016-17 and 2017-18 years. Furthermore, companies and trusts offer greater tax planning opportunities, allowing for profit distribution among multiple shareholders.
5. Asset Protection
When operating as a sole trader or partnership, the owner or partners assume complete responsibility for the business’s liabilities. In this case, personal assets, including one’s home, can be at risk if things go wrong. However, companies are treated as a seperate legal entities and provide reduced liability, although directors can still be held liable if the company is found to have traded while insolvent or defrauded creditors.
In contrast, setting up a trust with a corporate trustee provides an additional layer of protection. However, trusts have limitations, as profits must be fully distributed annually, while in a company, they can be retained. One way to overcome this limitation is by establishing a bucket company for the trust to distribute profits to. This structure involved three layers of setup and ongoing reporting and tax compliance costs.
Right structure, right time
Considering all the factors mentioned above, it is likely that your business will remain at the same stage of development. As it moves along the continuum of maturity and complexity, different structures will be required to operate at the optimum level. Starting with a simpler structure, such as operating as a sole trader hot-desking, may be more practical when researching the supply chain or developing the product or service model until you reach an income of 88K.
At this point, it may be advantageous to set up a company to save 11.5% tax (37% vs 39% including medicare) while your business income is between 88K and 180K. However, before admitting new shareholders, acquiring a major asset, entering into a high-risk project or other significant changes, you may want to consider alternate structure.
Start with the end
A word of balance, though. Whilst it may be practical to adopt progressive structures, it still pays to have a clear vision of the ultimate structure your business ultimately requires.For this exercise, start with the end – your vision of the business you set out to build, and the structure that would unleash its fullest potentials. Mark that as the destination for your path of progressive structures. Read a quick run-down of the common business structures here.
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Disclcaimer: The information provided within this article is general information only. None of the comments in these notes are intended to be advice, whether legal, financial product or professional. You should obtain specific advice regarding your particular circumstances from a tax or legal professional.
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