Key considerations in choosing a business structure
Thursday, 07 January 2016
 
Craig Hailston

Most business owners have the goal of building a scalable business with strong brand recognition. Initially, their focus is firmly on product development in order to produce a useful and saleable product or service.

In these early stages of development, implementing a robust commercial structure might seem like an unnecessary burden. Get the product right first, then figure out the detail when the business actually makes a sale, starts to expand or grow and operational issues become more necessary to address.

Unfortunately, shifting your business structure down the list of priorities can also cause major problems down the track. Once you have started, tax and legal ‘roadblocks’ can make it complex and extremely costly to change your structure.

For example if a restructure isn’t implemented carefully, you could find it triggers an unwanted tax liability for the business or its shareholders on the unrealised value of the entity. This could happen at a point in time before the business has actually generated any surplus cash to pay for these liabilities.

Avoiding these ‘roadblocks’ makes it important to think ahead and obtain advice early. Establish a structure that is both robust, but flexible enough to supportthe business and its activities now and into the future. The more effort you invest up front the greater the likelihood of positive returns to you, over the life of the business.

When deciding on which structure would be most appropriate to operate your business venture, there are many commercial as well as tax issues you need to consider.

Here are my ‘top’ issues to consider:

 

1. Tax

Tax is an important consideration, but it should not be the key driving force for choice of structure.

You need to consider how the structure is taxed on its profits, how your personal income and drawings are treated and how any capital gain that you may make on the sale of the business will be treated, in order to maximise your return upon sale.

But tax is only one consideration in the mix, along with the other commercial needs and objectives you have for the business as outlined below.

 

2. Commercial acceptance and operations

It’s important to have a structure that is commercially acceptable and easy to deal with. This is not so important if you’re dealing with individual consumers, but if your customers are other businesses or government departments in particular, they can have strong opinions about the type of business structures they will engage with. Most government departments, for example, will only deal with corporate structures. Banks, insurers, landlords and other third parties important to the operation of your business can also treat businesses differently based on their structure.

You also need a structure that is scalable and can grow with your business and its changing needs. Once again, this comes back to planning for the future and choosing a structure with flexibility to accommodate different opportunities the business might face as it evolves through various stages of growth and maturity.

 

3. Asset protection – safeguarding business and personal assets.

Many individuals overlook this aspect when establishing their business and run into problems down the line.

It’s the stuff of nightmares – how do you adequately protect your assets against creditors and other third parties if something goes wrong?

There is no quick fix. The best way to protect an asset is to have a number of protection mechanisms in place. These may include:

  • Having adequate insurance cover;
  • Reducing the possibility of being sued;
  • Owning assets in protected entities

A common form of asset protection is to ensure that those at risk do not own any assets. In the case of a business, this means the business is carried on in one entity and the business assets are held in another entity. The asset owning entity can rent the assets to the business entity.

 

4. Intellectual property protection

Central to the core of most businesses is some form of valuable intellectual property (IP) that has been developed. In the early stages, this IP will usually be developed in a structure which then becomes the trading entity. The IP could be protected by a patent, or other rights such as a copyright, but also needs to be protected from the trading and operating risks that arise. This is usually achieved by having the IP in a separate structure to the trading entity. The IP entity will then license the use of the IP to the trading entity.

Forward planning is also needed when deciding which entity will own IP, as moving IP from one entity to another can create legal problems and where the IP has value, you could also find you crystallise an unwanted tax liability as well.

 

5. Investor-friendly and ready

It’s important to think about the funding needs of the business and your options for obtaining funds.

For businesses that intend to raise capital through private equity, the structure needs to be both investor-friendly and investor-ready. Almost all professional investors will only invest in a business with a corporate structure, as it has clearly defined shareholders rights.

Another funding option might be government grant programs. In many instances, only companies are eligible to claim or apply for these programs, which can provide substantial amounts of cash to support business activities. The Research & Development Tax incentive is one example.

If the structure is unappealing to investors and limits their ability to access government funding, this will affect business opportunities, growth and ultimately the value of the business as a whole.

 

6. Exit

A successful exit is what most aspiring business owners strive for. Having a structure that provides choice and flexibility as to how you might sell the business is important.

In the case of a company structure, you have a choice to sell the shares in the company or the business separate from the structure. Each option has different commercial and tax implications and both are important to your investment in the business, and that point in time when you eventually want to realise and extract some or all of it.

Contact us