Choosing the best ownership structure for your business requires consideration of the potential costs, duties, personal liability, and flexibility.
Two common legal structures are partnerships, and proprietary limited companies. Although a company is a more complex structure, it is often preferred for the following reasons:
Protection from debt and liability: A company operates as a separate legal entity, capable of incurring debts and liabilities in its own right. This provides a veil of protection for the owner’s personal assets, as owners are not automatically personally liable for business debts.
Better Succession Planning: Gradual share buy-ins are a useful mechanism for succession planning in companies, allowing owners to sell their stake gradually without relinquishing immediate control. A buyer has a chance to become familiar with the company’s operations before taking outright control.
Easier Transfer of Control or ownership: transfer of control between old and new directors should not trigger tax liabilities, and can be achieved without disruption to the key operations of the business. And transfer of ownership between family members or trusts can occur without the burdensome and costly exercise of deeds or sale agreements.
Beneficial structure arrangements: a separate trading entity can rent business premises owned personally, or owned by separate investment entities.
Additionally, companies pay tax at a reduced rate, and a company can raise capital through its shares.
In comparison, a partnership structure is less costly to establish, and will be simpler for small businesses with low turn-over.
Important disadvantages to bear in mind are:
Liability: each partner is personally liable for the debts of the business in agreed shares. However, if the partnership breaks down or one partner is unable to contribute their share, the other is personally liable for the entire debt. Additionally, each partner is liable for the actions of other partners.
Disputes: The successful operation of a partnership depends on the ability of the partners to agree, and partnerships are usually based on joint control of the business. Therefore, if a dispute arises the operations of the business are often disrupted. Where disputes cannot be resolved, dissolution of the partnership, and closure of the business, is more complicated than a corporate liquidation, with more involvement required from individual partners and more time and stress.
Tax: partners are personally liable for taxation of business profit, and will more often than not involve higher taxation rates than a company.
Ultimately, the nature and size of your business and your risk profile will all be relevant, and consideration of the above issues together with good advice will help you to choose the best model for your business and ensure its success.
Corporate Ownership
Corporate ownership of a business is often recognised for its perks including the ability to raise capital, flexible tax arrangements, ease of transferring ownership and succession. However, it is important to consider the limitations of this structure before setting up your business with corporate ownership. Many perceived benefits are neutralised by law or practice. In particular, business owners who are looking for personal protection will find that it is limited in the following circumstances:
Personal guarantees – the universal position that company owners are protected from the liabilities of the company by the ‘corporate veil’ is distorted by the fact that lenders and creditors routinely call for directors to provide personal guarantees for their debts. It is unusual for a corporate trading entity to have any sort of financing or an overdraft without personal guarantees. Similarly, where business premises are leased, directors’ personal guarantees in the lease are the norm.
Onerous Directors Duties – there are strict statutory obligations associated with the role and responsibilities of being a director. The company structure does not afford protection to company directors who fail to lodge financial data and reports associated with the business activities as and when they are due. Also, directors are required by law to be continuously well versed in the company’s operations, income and debt levels. The time, costs, and penalties associated with these requirements can divert attention and resources from other aspects of the business.
Insolvent Trading: Directors who incur a company debt without a reasonable prospect of being able to repay the debt can be personally liable to the company and creditors for those debts, and additionally can be prosecuted and penalised. Directors must at all times ensure that the company is solvent.
Limited asset protection during family disputes: The corporate veil also fails to protect assets during a family law dispute. This is because the family court can ignore company ownership and instead consider the question “who has control”.
Liquidation claw backs: When a company goes into liquidation, a liquidator has the ability to “claw back” assets or funds that are recently transferred out of the company if it can be inferred that those transactions were designed to defeat creditors of the company. In other words, a company that disposes of an asset to a family member and later goes into liquidation will have that transaction scrutinised and possibly reversed.
Overall, a company can be a useful vehicle for owning, controlling and disposing of a business and will offer some personal protection for the business owner. However, there are limits on that protection which require careful consideration and advice.
For more information or to make and appointment with our Business Services team in either our Canberra or Queanbeyan office:
p: 02 6206 1300 | e: info@elringtons.com.au
