Choosing a Business Structure
The choice of the most appropriate business structure(s) to facilitate all that is important for an SME often requires the following competing factors to be taken into account:
- Risk issues;
- Growth and succession requirements; and
- Tax management.
Ordinarily when advising on the choice of a structure for a business client, all of the above factors will need to be considered. Importantly, the advisor will need to ensure that the structure has the maximum flexibility to facilitate changing business requirements.
With regard to the three essential issues, the structure should achieve the following broad objectives:
- Limit the personal and business risk associated with the conduct of the business activities;
- Facilitate any potential change in ownership requirements; and
- Take account of both the immediate and future taxation implications of the generation of business profits as well as the exit strategy of the client.
If there is a risk factor associated with the business or any part thereof, the choice of entity will often be determined by the entity that provides limited liability or asset protection.
The objective underlying the structure choice is to create an environment that provides protection or limitation of any risk of economic ruin if some unintended business consequence happens. In some instances there may be a need to compromise one factor with another to achieve the preferred outcome.
A company or trust (with a corporate trustee) is better suited in these instances to provide risk containment, because generally they provide limited liability. But the use of one entity may not necessarily be sufficient to provide risk protection.
Risk issues may require the following to be protected and quarantined:
- personal assets; and
- essential business-generating assets.
The need to provide the necessary protection requires a range of strategies, including:
- moving personal assets out of the ownership of the at-risk individual;
- separating business activities from the asset holding entity;
- using an entity that provides for limited liability; and
- using separate entities for businesses with different risk profiles.
Partnerships and sole trading activities expose the personal assets of the participants to business risk.
In the vast majority of instances, SME businesses are closely held and will be held by the client and/or their family. However, if it is envisaged that the client will need additional and external equity in the future, the choice of structure should be able to facilitate the introduction of the new equity without causing significant revenue costs.
The objective of the choice of structure with regard to this issue is:
- allow the introduction of new equity participants;
- facilitate employee equity participation; and
- take account of succession planning requirements.
If the business requires future equity, the use of either a company or a unit trust at some point in time is necessary.
Similarly, if the business strategy includes introducing employees, a company allows the employees to take advantage of Division 83A (employee share schemes).
Other points to note are:
- the use of partnerships raises the issue of joint and several liability.
- discretionary trusts are not suitable if external equity is required, and
- Division 7A is an ongoing issue for private companies and trusts, that use “bucket” companies.
There are two broad objectives that a structure should facilitate in relation to taxation:
- allow the client to manage the taxation impost that arises from business activities; and
- ensure that the exit strategy of the client attracts whatever taxation concession that is available.
To a large extent the matters that need to be considered with regard to business structuring naturally flows from the objectives being sought by the client and the issues discussed above.
Whilst these three factors are important in establishing a business structure, they should be regularly considered throughout the life of a business, as it is often the case that circumstances change to require the business to be restructured to better support the efficient operations of the business.