Aligning your Commercial Business Venture with the suitable Business Structure
When it comes to choosing a business structure for your commercial business venture, there is no ‘one size fits all’. This decision will largely turn on short, medium, and long-term business considerations. This includes personal liability, ownership, taxation, and internal structural flexibility to adapt to changing circumstances.
In the wake of the COVID-19 pandemic, it is more important now than ever to ensure the foundations of your business venture are structurally sound. The available business structures fall under two umbrellas: those that are and those that are not ‘separate legal entities’. Accordingly, it is essential to firstly understand the distinction and ongoing implications of separate legal identity.
What does ‘separate legal entity’ mean?
A ‘legal entity’ is simply a person recognised by law. The entity (just like you or I) has legal rights and obligations. Therefore, the legal entity can:
- buy and sell property;
- enter into legally binding contracts; and
- sue and be sued in its own name.
Accordingly, a business structure that is classified as a separate legal entity has legal rights and obligations in isolation of and separate to the individual(s) who govern its operations. This is otherwise referred to as ‘limited liability’: the liability of the business rests solely with the entity. From a commercial perspective, this may be strategically beneficial for businesses operating in volatile or high-risk business environments.
Commercial structures defined as a separate legal entity include:
- a Company
Commercial structures not defined as separate legal entities include:
- a Sole Proprietorship
- a Partnership
- a Trust (Discretionary, Unit or Superannuation Fund)
We now turn to assessing which business structure is most suitable for your business venture.
A business may operate through the structure of a company. A company incorporated under the Corporations Act 2001 (Cth) (‘the Corporations Act’) is defined as a separate legal entity. This gifts it with unique operating functions. Most notably, the company itself is comprised of three notably distinguished parts:
- the company – the corporal body encompassing the shareholders and directors;
- the shareholders – who own the company and provide capital funding; and,
- the directors – who manage and direct the company’s day-to-day operations.
Due to this division, the company is ‘limited by liability’. This means it will be legally responsible for its decisions as a separate legal entity: a ‘corporate veil’ will shield directors’ from liability, save certain exceptions carved out in the Corporations Act.
Other Key considerations include:
- Quick and efficient establishment
- Capital raising flexibility
- Profit distribution discretion
- Onerous director duties and annual reporting requirements
Ideal if you wish to minimise liability in a medium to large business venture.
Not ideal if you have limited financial resources and lack commercial expertise.
2. Sole Proprietorship
A sole proprietor is a natural legal person (you or I) who creates and runs their own business venture. The business itself and the sole proprietor are indistinguishable. In other words, you are the business. Accordingly, upon registration the business is not defined as a separate legal entity: you alone are liable for all actions of the business during the course of the business dealings.
Other key considerations include:
- Simple to establish and terminate
- Autonomy over business direction
- Capital Gains Tax benefits
- Lifetime of business contingent on lifetime of operator
Ideal if you require autonomy in a small to medium size business venture.
Not ideal if you wish to minimise liability and have the structural capacity to flex and adapt in a volatile business landscape.
Partnership is the association of two or more individuals or companies for the purpose of carrying on a business venture. Like a sole proprietorship, a partnership is not defined as a separate legal entity. Accordingly, the partners which comprise the partnership (limited in number by the Corporations Act) are jointly and severally liable for the obligations of the partnership in the course of its business dealings. This means that each partner is equally liable for breaches of legal and or equitable obligations.
Other key considerations include:
- Partnership obligations and liabilities solidified in Partnership Agreement
- Flexibility to reflect desired business trajectory, individual partner liability and control of business operations
- Capital Gains Tax restrictions
- Lifetime of business not contingent on lifetime of operators; partners may ‘sell out’ or ‘buy in’ (pending details of Partnership Agreement)
Ideal if you wish to combine resources, expertise, and capital in a flexible and transparent business venture.
Not ideal if you wish to limit your liability and minimise tax obligations.
A trust can be thought of as a fluid business structure. It provides a legal mechanism allowing the flow of the trust property (dictated by the Trust Deed) from one person (the Trustee) to an individual or group of individuals (the Beneficiaries). As a result, trusts are not a separate legal entity (save the formation of a Corporate Trustee, which is outside the scope of this article). The ability of the Trustee to transfer trust property to the Beneficiaries is contingent on the classification of the trust.
A Discretionary trust governs the Trustee with a discretion over what property is distributed to which Beneficiary. For example, a Trustee may decide to transfer ‘Beneficiary A’ 60% and ‘Beneficiary B’ 40% of the trust’s income. For this reason, A Discretionary Trust is best suited in family run businesses, where the discretion of a family member is trusted.
Conversely, a Unit trust governs the transfer of trust property to Beneficiaries in proportion to the percentage of ‘units’ held in the business. For example, where ‘Beneficiary A’ holds 50% and ‘Beneficiary B’ holds 50% of the total available units, the Trustee must transfer trust property to each Beneficiaries in equal portions. For this reason, a Unit Trust is often utilised in commercial dealings between unrelated parties where predetermined income yields greater confidence.
Other key considerations include:
- Marginal tax benefits
- Capital Gains Tax discount for certain trust assets
- Considerable set-up and ongoing costs
- Perpetuity period (lifetime) of trust limited to 80 years
Ideal if you wish to maximise tax advantages (‘income splitting’) and distribute trust property in either a commercial or family setting.
Not ideal if you wish to limit your liability or have flexibility in distribution of business profits.
Adopting the right business structure is an essential prerequisite for the success of your commercial business venture. Although this article provides important preliminary considerations, the decision you ultimately make should rest upon an informed understanding of associated legal complexities. If you have any questions in taking the ‘next step’ in your business venture, please do not hesitate to contact the team at Miller Sockhill Lawyers.