So you’ve just come up with a great business concept, given it a test-drive among your family and friends, and now want to go to the next stage. What do you do?
As ‘the Voice’ said in Field of Dreams, ‘If you build it, he will come‘. You need to put together the ‘playing field’ for your venture. In other words, you need a ‘business structure‘.
There is plenty of material on the various business structures you can choose from. The building blocks comprise sole trader, partnerships, companies and trusts. But almost all business structures these days involve a combination of two or more of these blocks into what we call a ‘hybrid structure’.
To cut to the chase, in our view there are really two main choices for a small start-up with a limited amount to spend:
- A company owned by one or more trusts. We loosely call this a company structure; or
- A company acting as trustee of a trust. We loosely call this a trust structure.
You need a company in either case to get the benefits of limited liability. For more information on this issue, read about how companies work.
Which option you go for will depend on a number of things. Primarily what your medium and longer-term intentions are. If you are planning on building the business to sell in the short to medium term, then a trust structure may be more appropriate. This is because accessing capital gains tax (CGT) concessions can be easier if you sell assets out of a trust. However, if you are planning to keep the business in the medium term and run it for profit, then a company is a good place to start, because you will benefit from the flat company rate of tax.
Now we can hear all the accountants and other lawyers out there crying – ‘What are you talking about! That’s not the right answer!‘ Fair enough. It usually isn’t that simple. But in our view, it is a good place to start. So let’s complicate things a little.
If the value you are building within your business largely comprises computer code (or some other IP that is protected by copyright, a patent or a registered design), then holding these assets in a company is a good idea. Why? Because if you sell these assets out of a trust, the gain will not qualify for any CGT concessions, (this is because these things are now taxed as revenue assets). Alternatively, if you are able to sell the shares in a company that owns this IP, you can potentially qualify for CGT concessions for the gain on the shares.
On the other hand, if the main asset you are building is goodwill or trade marks, then holding these assets in a company is a bad idea! This is because if you have to sell these assets out of a company (as opposed to selling the shares in the company), the company will not qualify for the CGT discount, whereas a trust will. So holding this sort of asset in a trust is a better idea.
Getting confused? So what do you do?
We have some general rules to work with:
- Always involve a company in your business structure – from the start. This will provide important limitation of liability – and could just save your house. Furthermore, people will start to take you seriously. If you think $1,000 is too much to spend on a company right now, then this is probably an indication that you don’t have the right attitude to really make this work.
- If you are building a business to generate profits, and are unlikely to sell it for a material gain, then a company is likely to be your best option. The shares in the company should be owned by a trust so you can spread dividends among family members, and to provide a level of asset protection for your investment in the company.
- If you are building a business to sell in the short to medium term, and do not envisage earning material profits in the short-term, then:
- If you are likely to sell to a big company, use a newly set-up (i.e. ‘clean’) company, and look to sell the shares in this company to the acquirer; or
- If you are only likely to sell to another small business person, then you should use a trust if you are developing goodwill or trademarks (e.g. from professional services), or a company if you are developing copyright, patents or registered designs (e.g. software and technology).
- If you are trying to do all of the above, then spend a little more money and set up a ‘dual business’ structure comprising:
- A company to carry on the trading activities and to hold any ‘revenue assets’; and
- A trust structure to hold any capital assets. This entity then makes these capital assets available to the trading company under a license agreement.
But the smartest approach is to give us a call on 1300 654 590 to discuss the best way to set up your ‘field of dreams’!