Why the right business structure can be essential
Many business owners do not understand just how important their business structure is, particularly when the going gets tough.
Two contractors... two very different results
We recently had two contractors come to us with very similar stories. Both had decent sized contracting businesses with about a dozen staff. The bad news was both businesses had been going backwards financially for quite some time with no reason to believe things would change, at least in the short to medium term.
One of the contractors had a disastrous outcome losing everything he and his wife owned.
The other had what could only be considered to be a good outcome. Admittedly it was a tough and stressful time, but he and his family were able to keep the family home, their personal assets and their investment property and went on to fight another day, setting up a new contracting business which is now highly successful.
The difference which made a difference
The sole distinguishing factor lay in how the two contractors had structured their businesses and the advice they received about that.
One had taken advice from his accountant and lawyer about how to structure his family’s affairs and acted on it. And, when it became clear he was facing problems, he promptly came to us for advice which he followed.
The other took no advice and ended up losing everything.
No matter how sound you think your business is or how long you have been in business, there is always a risk that your business or commercial venture can fail. So if you haven’t thought much about your business structure, now you have a good opportunity to do it. Waiting until you are in crisis and can not pay the bills is almost always too late.
Different goals can mean different structures
There are many different business structures and which one is suitable for your business can depend on many factors, including where you want the business to be in 10 or 20 years and what you see yourself personally doing in the future.
Sometimes a combination of structures will be best to achieve your goals. It can often involve balancing the need for asset protection against the desire for tax efficiency.
Regardless, it is crucial to involve both your lawyer and accountant in the process of establishing or changing your business structure.
The basic business structure models
In simple terms there are four basic, common business structures being: - sole proprietor, partnership, company and trusts.
From an asset protection perspective, the main differences between the structures are:
- Sole proprietor - There is no distinction between the assets and liabilities of the business and your own personal assets. This means all your personal assets like your home and your cars will be used to satisfy any outstanding debts of the business should things go wrong. Everything you own is on the line and at risk.
- Partnership – Like a sole trader, everything you own is on the line but it is worse because the partnership is not a separate legal entity so all partners are liable to pay and all their assets are on the line.
- Company – A company is a separate legal entity. It can hold assets in its own name and it has limited liability. This means that if things go wrong, all the assets of the company may be lost but not the assets of the directors or shareholders. That said, directors can be personally liable in some situations such as personal negligence or insolvent trading. However if you ‘play by the rules’ you should never have that problem. The keys here are firstly, to make sure you know what those rules are (a decent lawyer will be able to tell you what they are) and secondly to follow the rules… which is often where people let themselves down.
- Trusts - A trust is not a separate legal entity like a company. However, the trustee of a trust can operate a business and there can be good tax reasons why this is the best option. Combined with using a company (which has limited liability) as the trustee, this is very often a great solution for small to medium sized businesses like contractors commonly have, though it certainly is not the be all and end all.
A trustee of a trust operates a business for the benefit of the ‘beneficiaries’ who are usually your family members and associated entities like companies you operate or other trusts you have. In some cases, a trustee operating a business will be personally liable for the business’ debts if there are insufficient trust assets. However, trusts can be structured so that there is limited liability for a trustee. There are different trusts structures, such as a unit trust or discretionary trust. However, the details of each are complex and require specific legal advice.
What is best for contractors?
What suits you, your family and business can depend on many factors so you will need good advice from your lawyers as well as your accountants to make sure you get the best result and avoid, as best you can, the potential down sides of being in business.
It is never too early to take advice, change your structure and minimise the risks to your family. And provided you are not already in deep financial strife, rarely too late, no matter how long you have been in business, to make a change. Doing nothing however might just be financially fatal!