Business Legal Structures
The best form of legal structure in which to place your business is something you should get legal advice on, without doubt.
But, it is important that you think about what you want from your structure. When you brief your legal advisor, you should have a pretty good idea of what you want.
Even the best legal people can only really create something that suits you if you can tell them what you want.
The discussion below is a series of points to consider when setting up a business structure more than a roadmap on what that structure should be.
Because everyone’s business and personal situations are different, we cannot, and are not, advising you on the structure most suited to your enterprise.
One of the main reasons for company structures is to limit the liability of the owners for losses, accidents and other events that could result in financial impacts.
There is an increasing erosion of this protection as governments seek to make directors of companies more liable for a whole host of things they were previously protected against.
Even with these issues, a limited liability company structure may give you more protection than owning the business in your name or a partnership.
Directors are members of a Board and are the highest ranking managers of a company.
As such they can also carry ultimate responsibility if something goes wrong with the company. They can be fined or imprisoned by government agencies if the problem is serious. They can be sued by various parties if there are problems.
Although you can buy Directors insurance, it is not common for smaller companies and may be expensive.
Because of this exposure to risk, you may wish to think carefully before becoming a director of any business other than your own. Even more so if you are not involved with it on a day to day basis and not entirely familiar with what is going on.
You might get paid to be a director but the potential damage to your wealth and your reputation, if things go wrong, may simply not be worth it.
Many directors, and others whose personal wealth might be at risk in this way, put their assets in the names of a spouse or partner. This is fine unless the relationship goes sour and you face a divorce.
You might think that you are safe if you are not formally a director. However, if you act like a director by having a role in the governance of the business, you can be labelled a ‘shadow director’ and be just as liable as a proper director.
This is especially the case if you have a parent, friend or partner as a Director but they have little to do with the running of the company and you effectively pull all the strings behind the company. By the way, if you are planning to use another party as your director, you should be aware that, if your business fails, they can be made bankrupt along with you. This might not be a position you want to put your ageing parents in. The argument that your elderly mother, who is the director, doesn’t know anything about running a business and therefore is not liable for its debts will no longer stand up. Directors are expected to be competent and they will be treated as though they are.
A firewall is a bit of business slang that means to erect some defence against damage from an outside source causing problems for property of yours. It is often used in reference to computing systems and the need to keep hackers out.
The Operating Entity
At the heart of your business is the operating entity. It makes products or offers services, employs people and runs up bills for the input resources it needs.
This is the riskiest part of your business empire, it makes a lot of sense to quarantine it as much as possible from other parts of your empire.
If you are an operation of any size, your operating entity is likely to be owned by a limited liability company.
If it gets into trouble and has to be sold or becomes bankrupt, you can lose not only the operating part of the business but also all the intellectual property (IP) like brands and domain names plus any previous profits and any capital in the bank accounts of the business. Even moving that money out at the last minute will not save it as, increasingly, insolvency practitioners can claw back last minute payments and where one creditor has been favoured over another.
This suggests two other layers of legal entities you might want to wrap around the operating company.
The Holding Entity
You should consider a ‘holding’ entity to own the valuable assets like profit, capital and IP.
This might be another limited liability company or a trust. Its purpose is to quarantine these valuable assets so that if the operating business should fail or be sold you don’t lose all the wealth you have accumulated.
The holding entity owns the assets and either leases or rents them to the operating entity under a management contract. Because the assets remain the property of the holding company, they may not be lost if the operating company fails.
In addition, any money advanced to the operating company might be in the form of loans that are secured so that, if it does fail, one of the first claimants to what is left will be the holding company as a secured creditor. Simply giving money to the operating company without a legally constructed secured loan is to put your wealth at more risk than it needs to be. Shareholders are the last to be refunded money if a business collapses so simply owning the shares of the operating entity is not nearly enough to protect your interests...(click to article for more)
The use of a holding entity is complex and you should seek the advice of a professional. Take care when finding a professional as you don’t want to find out down the track that your structure is not very sound (Choosing Professional Advisors).
The main purposes of the holding entity are to:
- Quarantine valuable assets from a failure of the operating company and
- To stockpile profits in a lower tax environment than personal income and somewhat safer.
- To insulate your assets from your personal liability
You could also give some thought to a ‘service’ entity either at the outset or down the track.
These provide services to your operating entity where that is convenient.
Use them to provide labour that might be shared over several operating entitles.
Rather than run several payrolls, it is administratively easier to run one payroll in the service entity and then rent staff out to the operating entities. In fact, since the service business can charge a premium on the labour (make a profit). It is a way of moving money out of the operating entity, where it is vulnerable, to the service entity where it is less vulnerable. It might be subject to problems relating to employment.
Be aware that there may be rules about how much money can be transferred to a service entity.
If the shares of the service entity are owned by the holding entity, it can export its profits to the holding entity. It will, therefore, have few assets at risk if the service company gets into trouble.
Go to the Full Article now to read about:
Retirement Entities: In some counties, retirement entities can have special protections and lower tax and might therefore be a good firewall.
Succession Planning: It may be that you expect to keep your business and pass it on to following generations of your family.
Exit Planning: Exit planning is planning to sell your business at some future date or working out how to take out a big chunk of wealth to help make you comfortable into the distant future.
See the article Profitable Business Exit Sale as well.
Recapping Business Structures
The ideal business structures for your business is a complex topic and definitely needs good professional advice.
You may not want to bother with this when starting up your business but, be warned, it can be quite difficult to do a lot of this later without paying unnecessary taxes to transfer assets into new entities.
Alternatively, not to do it places your wealth at risk.
Much of what we have discussed here relates to tax planning and the liability laws. Rather than setting up a structure and leaving it untouched for 20 years, you would be wise to have your accountant and/or lawyer do a regular check of your structure. This ensures it is still serving its purpose or if it should be tuned to compensate for some change in government legislation. Aim to do this at the time you get your annual tax returns back from your accountant. Remember to do it at least annually.
We consider your business structure to be of similar importance to that of working out what business to be in when it comes to protecting your wealth now and in the future.
Watch The Video Now
Mark Rogerson, Rogerson Kenny Business Accountants, discusses the differences between a Company and Family Trust. This is a clear, easy to understand explanation.
Watch this five minute video
on the link below
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