Protect Your Business: Why Legal Structure is So Important
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There are many sources of business risk
When starting your business it’s important you understand that there are certain risk events you can control and other events you can’t. Changes in government legalisation or adverse weather conditions (drought and flood etc) are examples of risk events outside of your control. So to operate a business free of risk, you are exclusively limited to managing risk events that you can control.
To do this successfully it’s important to set up the correct business structure from the start of your business life.
This is a vital step in the initial stages of your business development because while the structure can be changed later, it often involves tax consequences and focus being drawn away for the business itself.
Why the correct legal structure in business is so vital (and what's at stake if you don’t get it right)
Identifying and managing risk is an integral component of building a successful small business. It would be impossible to remove risk from all situations but you can take steps to remove or reduce business risk.
Ensure you are in the legal correct structure for your business and industry
Have relevant agreements in place to determine who can make what decisions
Meet regularly to review all aspects of the business
Ensure all bank accounts have proper authority levels
The below case study is of a business in the mining support industry that we have helped. It is a strong example of how vital it is to implement the correct legal structure when you set up your business.
This business had initially been set up as a partnership of five people, where in fact it should have been set up as a company.
Over time, several partners needed to exit for personal reasons. Each exit presented their own issues. The first exit would have resulted in the old partnership being dissolved and a new partnership having to be created. This is because a partnership is required to change or be updated if it has different members. Luckily we were able to help stop this requirement. Had a new partnership been required a new ABN, new insurance and other important restructures would have needed to be actioned.
The other exits were the result of choosing the wrong legal structure and the more extreme difficulties that may arise if a partner takes advantage of the structure. Of the partners left, one funnelled money from the business accounts to his own and left large bills with the ATO, while also purchasing an expensive car signed over to the partnership to finance without their knowledge. ( Lending conditions have since changed.) After his actions were discovered by the other partners he disappeared taking the car and funds with him, leaving the remaining partners to repay the ATO debt and the car loan. The business nearly folded due to debt and the amount of time and resources the remaining two partners had to devote to recovering any money was exponential. After legal fees that nearly matched the loan on the car, they eventually recovered the vehicle and sold it for a fraction of the purchase price. This partner was then removed from the partnership, while another partner chose to leave due to illness spurred on by stress from the events.
Types of Legal Structures
The most common types of legal structures are Sole Traders, Partnerships, Companies, Unit Trusts and Discretionary Trust (also known as Family Trusts).
A Sole Trader is what some people call consulting or working on an ABN. A sole trader is “on the line” for everything and assumes all of the risks.
A Partnership is 2 or more people working together. Each partner is responsible for everything that happens in the partnership including actions by the other partners even without their knowledge. A partnership is one of the riskiest structures.
A Company is treated as a separate entity under the law for most issues. It can be sued in its own right. This is generally the safest structure.
The risk of a Trust is defined not by the fact that it is a trust but by who the Trustee is. The trustee is the entity that controls a trust.
What Legal Structure should your business be? (and what to do next)
There is no correct structure for a business. While one main driver is a risk; the size of the business, future plans, funding and investment, parties involved, taxation and many other factors come into play when deciding which structure is right for you. Often the correct structure is two of the above-listed entities working together to offer security and flexibility. Our business consultants in Perth can talk you through all of the relevant issues to help you decide what structure is best for you and your business.