Business Plan –Stage 5 – Preparation for trading
It never ceases to amaze how often start-ups
and existing businesses alike find themselves in a legal or financial wrangle because the owners have not chosen the appropriate legal structure for their business. If the structure is wrong, then insurance and licences are often found to be void. This is a common and costly mistake. Many business failures start with this issue, when owners find they cannot get paid for work done or cannot expand their financing to take advantage of a market opportunity. Banks, Courts and insurance companies have little compassion for owners who through negligence or sloth have failed to structure their business appropriately. If you construct a thoughtful and measured Business Plan you can reduce if not eliminate costly mistakes.
Reviewing the business structure as part of the annual revision of the Business Plan helps all owners maximise the efficiency, profitability and tax planning opportunities for their business.
This guide is based on the Australian and UK model, so please check the specifics if you are reading this elsewhere.
There are four basic business structures that represent most of the SME market. It is vital that the business owner understands the fundamental differences between them before registering for licences, trading names, bank accounts, ABNs, insurance, leases etc. It is possible and very common for businesses to change their structure over the passage of years.
Each structure has it’s strengths, weaknesses and separate legal status. I have chosen not to include Public Companies and Incorporated Limited Partnerships in this blog simply because these are structures most commonly used by larger businesses and joint ventures. Furthermore Trusts and Foundations are more complex legal entities than these pages allow.
• Sole Trader
• Partnerships general
• Partnerships limited
• Private Company
o Trusts & Foundations
o Public Company
o Incorporated Limited Partnerships..
I have provided links at the bottom of each section for you to check your situation with the relevant Tax Offices for Australia, UK and U.S.
Sole Trading;
As the name implies is the simplest format to carry on a trading enterprise. However, it is important to recognise that all the financial liabilities reside in the owner. It means that the owner cannot separate the domestic assets from those of the business. It means that bank accounts and loans are secured against ALL of the owner’s assets, including the home, unless specific legal arrangements have been put in place them in a separate legal entity such as a Trust.
Benefits:
• It is swift to set up.
• Simple paperwork is required.
• Costs for administration and accountancy are minimal.
• Generally lower regulation thresholds.
• The business owner can employ any number of people and make all appropriate tax calculations and payments for employees.
• The owner is responsible for all insurance policies governing the business and it’s staff whether at the place of trading or elsewhere.
• The owner can sign any and all contracts on behalf of the business.
Disadvantages:
• There is an unlimited financial burden on the business owner to guarantee all loans.
• Responsibility for the impact of faulty goods or services provided through the trading activity rest entirely with the business owner.
• Income for the business is treated as the owner’s personal income.
• Tax reduction tools are minimal.
• Insurance policies are restricted.
• The business ceases immediately with your death, incapacity or bankruptcy.
Check the legal structure that best suits your business and your financial status via these Tax Office links :
Australia – https://abr.gov.au/For-Business,-Super-funds—Charities/Applying-for-an-ABN/Business-structures/Individual-Sole-trader/
UK – https://www.gov.uk/working-for-yourself
US – http://www.irs.gov/Individuals/Self-Employed
Partnerships General;
Defined variously as a structured relationship between any number of people with the specific intent of running a business in common with the intent of making a profit.
It is vital to understand that whilst partners can share in the workload and responsibility for running and administrating the business, all partners are increasing their exposure to unlimited risk. “All partners are jointly and severally liable” for all debts and liabilities incurred by the business.
A Partnership is not a separate legal entity. It is important to recognise that all the financial liabilities reside in the partners collectively. It means that one partner cannot opt out from the liabilities of the other partners. It means that any claims for the impact of faulty goods or services reside in each of the partners. It is also vital to understand that any negative financial history and current status of each partner will reflect on and impact upon the business loans, leases, insurances and indemnities.
Partners cannot also be employees of the business, instead each partner is an agent of the business. Each has the ability to sign any contract or obligation on behalf of the other partners. There is no legal requirement for one partner to inform any other partner of their signing a commitment or obligation on behalf of the partnership.
Written Partnership Agreements are essential is assigning roles, functions and responsibilities, however, the underlying principle of shared liability cannot be contracted out.
Benefits:
• It is simple to set up.
• Repetitious but simple paperwork is required.
• There is a shared management base and expertise.
• The Partnership can access a wider range of capital and loans.
• The business can employ any number of people and make all appropriate tax calculations and payments for employees.
• The partners are jointly responsible for all insurance policies governing the business and it’s staff whether at the place of trading or elsewhere.
• Costs for administration and accountancy are minimal.
• Some tax planning advantages and schemes.
• Generally lower regulation thresholds.
Disadvantages:
• There is an unlimited financial burden on each of the business partners to guarantee all loans committed in the name of the Partnership.
• Responsibility for the impact of faulty goods or services provided through the trading activity rest entirely with the business partners.
• Income for the business is treated as the partners’ personal income in proportion to the specification laid out in the written partnership agreement.
• Insurance policies are restricted.
• The business ceases immediately with any partner’s death, incapacity or bankruptcy and has to be re-formed, incurring legal and administrative costs.
• A partner can abscond leaving all debts to the remaining partners.
• There is joint responsibility for all business functions even where separate roles have been designed and designated to each partner.
• Transferring ownership can be costly and time consuming.
• Any partner can independently decide to dissolve the partnership.
• Dividing Partnership assets including Intellectual Property and work in progress can be costly and time consuming.
Partnerships Limited;
Limited Partnerships are most often formed to enable additional people to contribute capital to a business and share in the business’s profits. Most specifically the ‘limited’ partners do not share in the liabilities of the business. In order to avoid legal liability, limited partners are prohibited from any involvement in the management or running of the business. Limited partners have no legal authority to act on behalf of the Partnership. However, the business must have a minimum of one General Partner in order to trade. The General Partners share all liabilities as above.
Written Partnership Agreements are essential in defining who are full partners and who have limited liability. Getting the structure set down is one thing, preventing ‘drift’ over time or when trading becomes more difficult has resulted in Courts frequently ruling that individuals have assumed management functions or controls to the extent they have ‘segwayed’ from limited liability to full partnership by default.
Here are the Partnership Tax Office links :
Australia – https://www.ato.gov.au/business/starting-your-own-business/choosing-your-business-structure/partnership/
UK – https://www.gov.uk/set-up-business-partnership
US – http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Partnerships
Company Private;
A company is a business entity that has a separate legal existence from its owners. The owners of the company are known as members or shareholders. Its legal status gives a company the same rights as a natural person which means that a company can enter a contract, take on an obligation, incur debt, sue and be sued.
Companies are managed by company officers who are called directors and company secretaries.
Small business owners often use a type of company structure ( a proprietary limited company Pty in Australia), that does not sell its shares to the public and has limited liability.
Larger companies that do sell shares to the public can still limit their liability.
Benefits:
• It is a separate legal entity.
• The owners enjoy limited liability.
• Tax rates are often lower than personal tax rates.
• The company can employ any number of people and make all appropriate tax calculations and payments for employees.
• The company is responsible for all insurance policies governing the business and it’s staff whether at the place of trading or elsewhere.
• The company can assign and assume any contracts and liabilities.
Disadvantages:
• Some banks still insist on Director’s providing personal guarantees or debentures against company loans..
• Responsibility for the impact of faulty goods or services provided through the trading activity rest entirely with the company.
• Income for the business is taxed separately from those of the Directors and shareholders.
• Tax reduction tools are extensive.
• Insurance policies are wide ranging.
• The business continues after the death or incapacity of it’s Directors and shareholders.
• Companies placed in Administration or Receivership lose all control over their former assets.
As companies are legal entities in their own right, there are additional and ongoing legal obligations that company officers must comply with under the legislation of the country within which they trade and/or are taxed. Failing to comply with these laws may result in formal regulatory action against the company and/or its officers.
Here are the Private Company Tax Office links :
Australia – http://asic.gov.au/for-business/your-business/small-business/starting-a-small-business/small-business-starting-a-company/
UK – https://www.gov.uk/limited-company-formation
US – http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Single-Member-Limited-Liability-Companies
This extract is taken from my weekly blog on how to research and construct a meaningful Business Plan. All the information is FREE and will be FREE to download from www.JGID.com at the end of September 2015.
JGID produce a fully functioning Business Management Software that can be configured to grow with the scale of your business. From sole trader to a million dollar turnover, JGID business management software is aimed at increasing business efficiency, maximising profits and increasing the quality of life for it’s business users. We either succeed or you get 110% of your training and implementation fee returned. Now that’s a promise worth exploring. Just Get It Done, www.JGID.com
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Thank you for reading this blog and please feel free to add any comments to the discussion.