Getting the right business structure is a bit of art, and a bit of science. It comes down to balancing several, often competing, objectives.
When asked what structure to use, we like to apply several key principles and ‘rules of thumb’ to get the right answer.
Keep risks separate from wealth
The first general principle is to always keep a separation between risk and wealth.
You should choose how much you put on the table in the form of resources at risk in your business venture.
If you don’t maintain a separation between risk and assets, then you will by default risk everything for potentially little gain.
This separation can start simple, like having one person hold your home and the other run the business. The home owner may even lend seed capital to the business person and take security over any business assets (like IP or stock).
Next you can add a company with limited liability, to separate business risk in the company from the wealth in the hands of the owners. The directors are still exposed to a higher risk than the shareholders, so you may want to combine this with the first strategy, i.e. have one person hold the shares and your home, and the straw-person acts as the director.
Further down the track, you can separate business risks in one entity from business assets (or wealth) in another. We call this a dual-entity structure. The business asset holding entity makes the assets available to the business risk entity. You need to consider PPSR registrations to ensure that this strategy actually works.
Finally, as your business grows in value and becomes an asset in itself, you can add a trust to get two-way risk quarantining, so:
- Your personal wealth is protected from your business risk; and
- Your business wealth is protected from your personal risk.
Tax optimisation probably comes next in the list of priorities.
When you start out on an uncertain venture, you’re more likely to make losses than taxable profits. So, the first thing you need to consider is if you cash out or carry forward your losses.
Cash out options include:
- Off-setting the business losses against other income, say from a day job or spouse. This will require the losses and the income source to be in the same taxpayer’s ‘hands’; or
- Getting cash back from the Government in the form of R&D refundable offsets. This will require you to undertake the R&D in a company.
It can be harder to carry forward losses in trust structures or in companies owned by trust structures. This may require you to form a ‘partnership of trusts’ (rather than a unit trust) or make family trust elections.
When things get going, you will then start to worry about paying too much tax.
By this stage, you will want to be able to do three things:
- Claim as many deductions as possible;
- Spread your profits among as many taxpayers as possible; and
- Cap your rate of tax at the flat company rate of 30%.
This will require you to carry on your business through a company and hold your interest in the company through a trust.
Capital gains on exit
Finally, you will want a structure that facilitates you:
- Being taxed on capital account when you sell – so your tax rate is halved; and
- Being able to access the Small Business CGT Concessions – so your tax rate is eliminated.
It is a good idea to understand from the outset whether your medium-term goal is to sell out or hold for the long-term income stream. It is also helpful to know what sort of acquirer is likely to buy your business.
If you are planning on an exit to a large corporate, then you are likely to be able to sell the ‘equity’ in your business (i.e. the shares), as opposed to the underlying business assets. This makes it easier to operate through a company and still qualify for the capital gains tax (CGT) concessions.
If you are likely to sell to another small/medium business owner, then they are less likely to want to buy your equity, as they will want to buy your assets into their own business asset vehicle. In that case, you may want to look at a ‘transparent’ structure, such as a trust.
20% ownership interest is a key threshold for the Small Business CGT Concessions, so be aware of this when allocating or selling-down equity.
There are three main sources of start-up funds:
- Equity – usually from your personal wealth (and that of family and friends);
- Debt – usually from friends or banks; and
- Suppliers (trade credit) and future revenue (key customers).
You need to be able to explain your business structure to funding sources. The more complex the structure, the harder it will be to raise funding at a reasonable cost.
If your structure involves a discretionary trust then you need to be careful not to break the ‘chain of funding’, i.e. if you lend money to the trust you must charge interest at least equal to your personal funding costs.
Where to from here?
The information contained in this post is current at the date of editing – 22 September 2023.