While many prospective small business owners pour countless hours into understanding their market, their customers and their products and services, few devote as much energy to evaluating and choosing the best legal structure for their business.
Like it or not, your legal structures can shape your business’ evolution. There are several forms of business structure, which may be appropriate for your business and each has its own pros and cons.
Implications Of Your Preferred Legal Structure
Your preferred legal structure will reflect the type and projected size of your business, your personal circumstances and your growth plans for your business. Your choice can influence:
- Potential personal liability
- Responsibilities as the business owner
- Tax liabilities
- Asset protection
- Ongoing costs and amount of compliance paperwork required.
Happily, you can change your business structure as your business grows or your personal circumstances evolve, but careful consideration is required before undertaking a task.
Types Of Legal Structures
Naturally, working out which legal structure provides your business with the most advantages at the least cost and complexity while helping you achieve your goals lies at the heart of any legal entity assessment.
Below are the most popular business legal structure entities together with the factors to consider before adopting your business structure.
1. Sole Trader
Easily the simplest form of a new business entity. Under a sole proprietorship, one individual is solely responsible for the company’s profits and debts.
So, if you want to be your own boss and run a business from home or an online shop, a sole trader allows you complete control. This structure lacks any protection of your personal and professional assets, which may be an issue later as your business grows and you build relationships with more customers and suppliers, increasing your liability.
A partnership structure enables two or more individuals to take an ownership position. There are two forms. In Limited Partnerships, one partner has control of its operation, while the other partners contribute to and receive only part of the profits. In General Partnerships, all profits and liabilities are shared equally.
This is the preferred entity for those wanting to go into business with family members, friends or business partners. A partnership allows its partners to share equally in profits and losses and to make collective.
A company is a stand-alone legal entity. It can run up debt, sue and be sued. The company’s owners are its shareholders. Their structure limits their personal liability, as those shareholders are not responsible for the company’s debts. A company is a more complex legal structure. Its establishment reporting costs are higher. Similarly, a company may be either a private or a public entity.
A registered company must have a minimum of one director and a company secretary. A director is responsible for managing the company’s business activities.
Within a trust structure, a trustee is responsible for managing the business on behalf of the trust’s members or its specified beneficiaries. A trust is not a separate legal entity. A trustee may be an individual or a company. The trustee is legally liable for the trust’s debts and may use its assets to repay those debts.
A trust is set up through a trust deed. There are two main forms of trust. In a Discretionary Trust, the trustee has discretion over how funds are distributed to individual beneficiaries. A Unit Trust is divided into units with their income or asset distribution set by the number of units held by each trust member.
Co-operatives are member-owned legal structures. They have a minimum of five members, each with equal voting rights regardless of their level of investment or management involvement. A co-operative is a separate legal entity hence directors, members, managers and employees are not liable for any debts it incurred unless they result from fraud, negligence or recklessness.
6. Incorporated Association
Incorporated associations are entities usually established for charitable cultural or recreational purposes. It is little used for small business purposes.
Factors For Consideration In Selecting A Legal Structure
Many prospective new business owners struggle to decide which legal structure to select. You should review consider your startup’s capital base and likely funding requirements, its risk profile and growth prospects. Migrating to a new legal structure once you’ve registered your business can be complicated and expensive, so identifying the right entity is critical.
If sole control over your business is a deal breaker for you, a sole proprietorship may prove to be your best choice. A partnership agreement also allows for sole control providing your partners agree to that provision.
A company comes with the least exposure to personal liability, as it is a separate, legal entity. So, customers and creditors can sue the company but are quarantined from shareholders’ personal assets. Partnerships share liability between their partners as outlined by their partnership agreement.
Consider your business’ goals and which form of legal entity caters effectively for them. Ensure your goals and your business plan are aligned with your legal entity. Your structure should enable growth and evolution, rather than restraining it from achieving its potential.
For most startup businesses, the amount of time and resources you need to devote to compliance can be a burden and a distraction from establishing and growing your business. Alternatively, the wrong legal structure can be a barrier to raising external capital to fund growth.
5. Raising Capital
Should you anticipate a need to access external funding via private equity or venture capital investors or bank loans to grow your business, setting up a company may be a more effective way of accessing external funding than a sole proprietorship structure. Companies can sell shares and secure loans and lines of credit, while sole proprietors can only access funding by leveraging their personal assets, using personal guarantees.
The legal entity you choose for your small business ultimately influences everything from its day-to-day operations, to your tax exposure, to your personal liability. Look to choose a business structure that provides you with the right balance between legal protection, control and growth benefits.