Let’s be honest – legal entities and business structures can sound like a pretty dry and complicated topic. We can’t really sugar coat that, but we can tell you that if it’s not something that is addressed and set up to suit your business, you could be missing out on some very important advantages, and exposing your business and your assets to more risk than is necessary. Stick with us on this topic – it can be the difference between a business that thrives and a business that struggles.
Do You Even Know What Entity You Have?
As a threshold issue, if you don’t know exactly what your current entity structure is, then that’s ok (it’s not easy, and it’s not necessarily a ‘water cooler’ kind of topic), but this article is definitely for you and you should contact our expert Business Law Team so that we can help you identify it.
Common Entity Types
This three most common entity structures we encounter at EL are:
1. Sole Trader/Individual:
This is effectively the ‘starting point’ for many businesses. A sole trader is a single person who is carrying on a business under an ABN. An individual is of course capable of suing and being sued. In order to change the business structure, a sole trader must ‘transfer’ the business to another entity, which can be costly and will require payment of transfer duty based on the value of the transfer.
Income Distribution: all income of the business is distributed to the individual, which is to be declared in conjunction with any other income that individual earns. This is typically not an issue in the initial phase of a business while profit is building, but can be problematic if the individual is already paying a high rate of tax, as all profit earned by the business is also taxed at that rate.
Risk Profile: all assets owned by the individual can be at risk in any claim against the business. For example, if a customer/client or employee of the business sues the business and is successful, the individual may be required to sell other personal assets in order to pay out the claim, or risk declaring bankruptcy if the value of those assets are not enough to pay the claim.
2. Company:
A company is a separate legal entity to the people/persons that control it. The company is capable of suing and being sued. The controlling persons can be easily changed from time to time, which allows flexibility for business owners wanting to sell or bring other business partners on board.
Income Distribution: companies have additional flexibility when it comes to distribution of income, as it is ultimately distributed to the ‘shareholders’, which could be the individuals who control the company, another entity controlled by those individuals (for example another company or trust), or another entity controlled by a third party (for example an investor who has contributed funds to the business but does not assist in the day-to-day running of it). However this flexibility is somewhat limited, as the income must be distributed in accordance with the percentage of shares held by the shareholders.
Risk Profile: the company can be sued, and all assets held by the company are at risk in any claim against the business. If the company does not hold enough assets to pay the claim, the company may be required to wind up. Except in limited circumstances, typically the assets of the individuals who control the company are safe from any claim, so at worst the business will fold, but the individuals will maintain any other personally-held assets.
3. Trust:
A trust is again a separate legal entity to those persons/entities who control it. The trust is capable of suing and being sued, and the controlling persons can also be easily changed from time to time by amending the trustee.
Income Distribution: trusts also have greater flexibility to distribute income, as it is distributed to the ‘beneficiaries’ of the trust, which can be individuals, companies, other trusts etc. A trust can be set up as a ‘discretionary’ trust, which allows the trustee flexibility to distribute income to the beneficiaries in any proportion that they determine.
Risk Profile: the risk profile of trusts is similar to that of companies, in that a trust can sue and be sued, and all assets held by the trust are at risk in any claim against the business. If the trust does not hold enough assets to pay the claim, the trust may be required to wind up, but similar to companies the assets of the trustees and beneficiaries are safe from any claim. In this situation, the business would fold but the individuals will maintain any personally-held assets.
There are of course other entities that you might encounter (such as partnership, unit trusts, etc), but they are largely either ‘outdated’ or only used in very specific circumstances. That does change from time to time based on things such as legislation and market preferences, but for now the three structures we have mentioned above are the most common.
Accounting Benefits v Legal Risk
In any decision around appropriate entity structures, often the accounting and legal advice are the same, which makes a decision easy. However, sometimes that advice can be conflicting, and you might find that trading in a certain entity will give you the greatest tax and accounting advantages, but will expose you to greater legal risk.
The classic example of this is a start-up business – in that example, while income is on the lower end because the business is starting out and growing, you’re often better starting off as a sole trader and minimising your accounting and set-up costs. The trade-off here is that you carry additional risk because your personal assets are exposed in the event of any claim. Depending on the type of business you operate and the personal assets you hold, you might be happy to accept that risk in favour of gaining some tax and accounting advantages.
At Enterprise Legal, we understand the competing accounting and legal benefits and risks, and we like to work with your accountant to discuss the best structure for you, both now and in the future. This way, you are armed with the knowledge from both sides and can make an informed decision.
How Enterprise Legal Can Help
At Enterprise Legal, we offer a free Business Health Check, in which we arrange a time to meet with you in-person or by phone/Zoom to assess your business needs. In addition to assessing other legal needs, this includes an in-depth analysis of your existing entity structure, and a discussion with you around other options, and the steps involved to change your structure.
We work with your accountant and other financial advisors to give you all the information, and discuss the best way to move forward. We can even create your new entity, amend your existing structure, or draft supporting entity documents to support your entity structure (such as company constitutions, association rules, shareholder’s agreements etc).
If you have any concerns or questions about your existing entity structure for your business, contact our expert Business Law team today:
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Disclaimer: because we are #lawyers, we have to say that the advice in this article is generic in nature and not intended to apply to everyone’s personal circumstances. Please contact our EL Business Team, as well as your accountant, for customised advice regarding your business structuring.
