Starting a new business is exciting. It’s an opportunity to weave your commercial ideas into something tangible, and productive. But it’s not without its challenges. The formation period allows you to lay the foundations of your future success. However, there’s a fine balance to be struck. Your business must be formed in a way that suits its initial operations. Ultimately, that means your business structure needs to start small. It shouldn’t be constrictive though; you also need a structure that will seamlessly facilitate growth. Essentially, your business structure is the vehicle that will transport your business into the future. The most common vehicles chosen by entrepreneurs are companies, trusts, partnerships, sole traders, and joint ventures. So which should you choose?
Companies, Trusts, Partnerships, Joint Ventures, and Sole Traders: Which Are You?
Choosing the right business structure might seem to involve a certain predictive element: what will your business look like in ten or twenty years? But in reality, its focus is largely on the present: what is your business right now? With that in mind, let’s take a look at the characteristics of the most common business structures.
Sole trader structures are simply a legal construct that forms around individual traders. Sole traders have the most autonomy in their commercial decision-making. Every business decision is made at the sole trader’s discretion. The sole trader business structure often attracts contractors and service-providers, who trade under their own names. If you start operating as a sole trader, you have complete ownership of your business assets. For example, if you use a vehicle for your work, you will be its sole owner.
However, you also assume all the liabilities that your work attracts. For example, if you default on a debt taken out to pay for professional expenses, you may lose personal assets as a result. Additionally, you will potentially pay income tax higher than that of companies or trusts. Nevertheless, working as a sole trader can be the best way forward; it simply depends on your business, and its stage in the overall business-cycle.
Companies are perhaps the most well-known commercial structures. They often exist to service large commercial operations, but they also offer a useful structure for some small businesses. The most important characteristic of a company is its legal identity. Under law, a company is effectively a person; it shares the legal rights of individuals, insofar as it can. That means companies can sue, and be sued. Companies are popular because they limit the liability of their individual ‘owners.’ Owners take the form of shareholders, who don’t assume responsibility for company debts. That is, unless personal guarantees are offered on loans.
Companies are also taxed differently to businesses of alternative structure. The rates of taxation imposed on companies are lower, which encourages business growth at a higher rate. A Company is also the best structure to accommodate raising money from investors and shareholder exits. However, companies are complicated entities. They are regulated heavily under the Corporations Act, and must be registered with ASIC. Establishing a company requires significant expenditure, as does a company’s ongoing maintenance. Consequently, they’re not always suitable for very small and relatively risk free operations.
Trusts are a popular vehicle for small businesses. Trusts are particularly popular among family businesses, due to their unique structure. Essentially, trusts place control of property or assets in the hands of an individual. That individual becomes the trustee. However, the trustee does not have beneficial ownership of the property and assets under its control. Beneficial ownership lies with the beneficiaries, whose entitlements are conferred by a trust deed. Those beneficiaries are usually family members within the business.
A trust deed will set out whether beneficiary entitlements are variable, or whether they’re fixed. It will also set out the rights and obligations of the trustee. One advantage of trusts lies in taxation. Trusts can distribute benefits to beneficiaries in a way that minimises their tax liability from one financial year to the next. That is particularly useful when profits are being shared among a relatively small number of people. However, trusts have a higher level of complexity to other structures, including with respect to their administration.
Partnerships arise between two or more individuals. Each partner in a partnership owes the other partners certain obligations. Those obligations are generally set out in a partnership agreement, although not all partnerships have such an agreement. Partnerships are not separate entities in the same way that companies are. Each partner is liable jointly and severally for debts of the partnership, as a result. However, by the same token, partners can share in the profits of their partnership proportionately to their equity. Partnerships are also quite easy to establish, and to restructure. Although personal differences between partners can be problematic, they are usually resolved by a partnership agreement. Ultimately, as a result, partnerships can be an efficient and effective business structure.
Joint ventures are a unique, and often one-off commercial undertaking. Usually, joint ventures take place between two companies that combine their resources to complete a project. The advantages of a joint venture are quite straightforward: both parties gain access to greater resources, risk distribution, and a wider field of expertise and experience. However, complications can arise. All joint ventures require the division of output, when the project is complete. Furthermore, both parties might have different objectives within the project, and they might have different approaches in mind. Resolution of those conflicts is easiest when there is a well-constructed agreement in place, prior to the project. Importantly, as well, joint ventures differ to partnerships in their division of resources. Rather than gaining a share of the venture’s profit, parties to a joint venture will receive a share of the output. That might be a certain quantity of resources, for example, or a proportion of products built.
Control, Asset Protection, Tax, and Exit: Choosing the Right Vehicle
By this stage, you may have some idea of the pros and cons of each business structure. You might even have one in mind for your own operation, or proposal. However, the essential features of each structuring vehicle can be distilled further into the following: control, asset protection, taxation, raising money and exit. From start to finish, each structure will determine your control over your business. The way you make decisions as a business owner will depend on the structure you choose. If you choose a company or partnership, your decisions will be collaborative. If you choose to be a sole trader, you will have complete autonomy. If you choose a trust, or a joint venture, you maintain some autonomy, but remain subject to the input of external factors, like trust deeds and joint venture agreements.
Structure will also determine the extent to which your personal assets are exposed. The safest structure in that regard is a company, but even that is not entirely without its risks. Similar could be said of trusts, which provide reasonable, but not impenetrable asset protection. Both are in contrast to partnerships, and sole traders, which can leave your personal assets exposed to creditors. Similarly, each structure will affect your tax liability.
Finally, there’s exit; each business structure will affect your capacity to leave your business. Sole traders enjoy the freedom to leave at their whim. Partners, on the other hand, are often bound by their agreements, as are joint venturers. Trustees can generally only resign in accordance with the trust deed to which they are bound. Company shareholders may also be bound by shareholder agreements, which can restrict the disposal of shares. As you can see, there’s a lot to consider when structuring a business. Chances are, you’ll need to make some concessions.
Structure is Everything – Here’s How to Get it Right
The importance of business structure cannot be understated. But navigating the complexities of sole tradership, trusts, partnerships, companies, and joint ventures is challenging to say the least. Given what is at stake, it’s important to seek professional guidance. An experienced commercial lawyer will be able to appraise your commercial position, and advise on an appropriate structure for your operations. In addition to that, a skilled lawyer will be able to help you establish an appropriate structure. That might include drafting or interpreting trust deeds, shareholder agreements, partnership agreements, or joint venture agreements. The right help can ensure that your business is structured in a way most conducive to profit, protection, and ultimately, growth.
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. Business people should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
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