Your First Business Decision – The Right Structure
Like most business decisions, when it comes to choosing the right structure, there are no simple formulas. As unique as each business is, so are the circumstances behind it.
Some clients want to commence operations with a simple structure and then amend that when the business has grown. However there may be stamp duty and capital gains tax costs that arise during re-structures. It is best to consider the likely future needs of the business and choose a structure capable of accommodating the long-term growth.
The Implications of Your Structure
The recommended structure will have implications on costs, tax planning, legal liability and protection of personal assets, and exit planning. Any good advisor would discuss the pros and cons of your chosen structure against each of these issues, with your circumstances in mind.
These issues can be highly complex and while we cannot comprehensively cover them here, we summarise below some key points. Further to this information we recommend you seek professional advice.
- Registration and Running Costs: Typically, cost increases as the complexity of your structure increases. A sole trader is inexpensive to set up because there are few legal and tax formalities. Partnerships, companies and trusts have increasingly higher start-up and running expenses.
- Tax Planning: Sole traders and partnerships have very little flexibility with regards to tax planning. In contrast companies and trusts yield greater flexibility, for example through income splitting which may enable some improvements in tax efficiency.
- Legal Liability and Personal Asset Protection: Businesses face potential liability from creditors if insolvent, attack by clients or customers for negligence, public risk and product liability. There are practical ways to limit liability from these risks, including securing adequate insurances.
Sole traders face great risk against their personal assets since they are personally responsible for the debts of the business. Partners in a partnership are also personally liable for all liabilities and claims against the business and accordingly all assets owned by each partner personally are exposed.
In contrast, company directors have limited liability. Their personal assets may be at risk only in limited situations, for example subject to creditors attack if the directors knowingly continue to trade while insolvent.
For even greater protection, a correctly set-up trust structure offers the strongest safeguards. In some complex circumstances ‘business risk protection structuring’ is undertaken, whereby multiple structures are created, for example a trust owning a shareholding of a company, which ultimately serves to quarantine assets or entities. An experienced lawyer or accountant is required to provide this specialised advice.
Over and above your chosen business structure, your advisor may recommend other asset protection strategies that your circumstances allow.
- Exit Planning: Forward planning will help to ensure that your exit strategy from the business can occur without disruption. Depending on whether you intend to wind-up the business on retirement, sell it in its entirety, or reduce or transfer your shareholding will determine which of the four structures works best. All four types of business structures can accommodate dissolution or share transfer, however with varying degrees of cost and complexity. Partnerships in particular may have some specific arrangements for the exit of one partner which are contained in the agreement and should be considered carefully at the time of start-up.
The consideration of these aspects will allow your advisor to form a view of whether the simplest structure of a sole trader is applicable, or whether it is justified to proceed with a more complex partnership, company or trust. Once this is clear, you will then be well-equipped to return to Start-Up World to establish your business simply and promptly.
Discussing the Broader Perspective
Your advisor will need to understand not just this business, but the broader financial and legal position of the founders. Through consultation with you it would be usual to explore the following areas:
- Are you constrained by the rules and regulations of your profession in determining business structure?
- What is the purpose and anticipated duration of your business and what assets are you likely to acquire?
- What extraordinary risks apply to your industry, profession or operations?
- Who else is to be involved in ownership, income share and decision making?
- What is your broader financial position, i.e. other assets, business interests and income from other sources? Do you have a spouse and dependents, or debt on other assets?
- What is your long-term objective for your business? Do you intend to build up a business for sale or to pass onto family members? To facilitate growth are you likely to admit new investors or owners in the future?
- Who will be your clients or customers? What are their requirements for engaging with your product or service?
- Do you have an expectation or plan of anticipated revenue, expenses and profit?
- How will initial capital be provided and by whom? How much additional capital might be required in future?
- What is your own level of interest and ability in being able to manage the accounting and financial aspects of your business? Do you prefer to be able to do this yourself, or to outsource to advisors/accountants?
By Stephen Ryan, Director – Edney Ryan Chartered Accountants