Should I change my business structure to a company?

Are you a sole trader operating your business under you own name?  If you’ve been in business for a while then this question has probably crossed your mind more than a couple of times.  And you’ve probably been given “advice” by other business owners or friends that you need to set up a company for your business…

But do you?

The answer is never cut and dry, and like most things in business, it really depends on lots of different factors.  This kind of decision shouldn’t be made on a whim and we always recommend you talk to a suitably qualified expert before jumping in.  Now, keeping in mind that the following is just general guidance, this is the process we go through with our clients at Wingr when this question arises…

Firstly, what is a company?

By law a company is a distinct and separate legal entity that can incur debts and earn income in its own right. It is entirely separate from its shareholders and the directors/officeholders.

There are two common types of companies in Australia:
1. a proprietary limited company, or a private company, which is generally identified by the ‘Pty Ltd’ in the company name; and
2. a public company, where shares are listed on the stock exchange to raise capital. This is generally identified by the ‘Ltd’ in the name.

Small business companies would be setup as a private company.

In Australia, companies are governed by the Australian Securities and Investments Commission (ASIC) and fall under the administration of the Corporations Act 2001. When you setup a company you will generally have the following people/roles:

1. Director: a private company must have at least one director (who must live in Australia). The director is responsible for guiding and managing the company for the benefit of the shareholders. A director has specific responsibilities and obligations set out in the Corporations Act 2001.
2. Secretary: a private company is not required to have a secretary but if they do, they must also live in Australia.
3. Shareholders: also called members, own the company and receive income in the form of dividends. A company must have at least one shareholder which could be in the form of an individual person, a company or a political entity. Shareholders purchase the initial share offering in the company – often at a nominal price of around $1. Depending on how you wish to split the ownership of the company will determine how many shares each owner/shareholder purchases.
4. Manager: A manager runs the company on a day-to-day basis and may also be a director and/or shareholder.

For many small business companies, there may be only 1-3 people who take on the roles above. In some cases, there may be a single person who is the director, manager and shareholder of the company however, please keep in mind that this does not reduce the legal or compliance requirements for the company in any way.

What are the advantages of operating your business in a company?

There are many advantages to operating your business in a company and the following are generally what prompts a business to move into a company structure:

• Asset protection – the assets of the company are separate to those you own personally, so it limits your personal liability and risk.
• All business and legal arrangements are in the name of the company, not in your own personal name.
• Companies allow for continuity of management and ownership – shares can be transferred and directors can be added or removed.
• Companies have a fixed tax rate of around 25% – lower than the highest individual tax rates.

What are some considerations before making a decision?

As we said, companies aren’t always the right structure for every business, or sometimes it’s not the right structure yet, so you should be aware of the following before making a decision:

• Companies are more highly regulated than other types of structures and have more ongoing compliance/regulatory activities and costs.  There are annual registration fees and requirements as well as additional costs for managing your tax affairs.  You also need to keep more documentation (minutes) when you make decisions for the business.
• The cost to setup and maintain a company structure is higher than other structures and due to the varying sizes of companies that are regulated by the Corporations Act, the legislation is very complex.  There are also more government fees when establishing the company in addition to those ongoing annual registration fees.
• Due to the reluctance of some lenders, directors or shareholders may be required to personally guarantee loans in order for the company to obtain finance so your personal assets may still be at risk if the company cannot make repayments on those loans.
• Where directors fail to meet their legal obligations, they may be personally liable for the company’s debts, so again, the personal assets could be at risk if you don’t do the right thing.

What triggers might indicate a company is the right structure?

Often the decision to change your business to a company structure comes down to timing.  There are certain indicators or triggers that we would look for that tells us the benefits of a company would outweigh the costs and regulation.

Some of these triggers could be:

• Tax benefits – If your business is starting to make more money, and the profits you are making are higher than the amount of money you need to cover your personal living costs, then it might be time to look at a company.  This would allow you to retain some of the profits in the company, which pays tax at a lower rate than you might personally.  You might also want to be able to keep some money in the company to fund future investment or expansion.
• Asset protection – This might be a bigger factor for you if your business operates in a risky environment – eg a higher financial risk or risk of physical injuries or litigation.  By operating the business under the company you could protect your own personal assets in the event the business is sued.  When you don’t have a lot of personal assets, this probably isn’t such a big consideration, but when you start accumulating assets such as buying your own home or investment property, this might become more important.  As I mentioned above, directors still take on some personal risks but this is generally only if they act negligently or outside their legal authority.
• Becoming an employee – If you’ve been operating as a sole trader and not really doing a good job of putting money aside for tax or superannuation, then the idea of being a formal employee of the company might be appealing.  This would allow you to pay yourself a regular wage and regularly pay tax and super contributions for yourself.  Whilst you can achieve a similar outcome as a sole trader without being an employee, you cannot officially be on the books or process payroll which often means things like tax and super are overlooked.
• R&D Tax Incentive – if you intend to claim under the Research & Development Tax Incentive Scheme your business must be a company structure.
• Flexibility – if you want to have some flexibility for changing ownership in the future then a company would enable this quite neatly.  For example, if you wanted to change the owners of the company, you can sell shares from one shareholder to another.  Similarly, if you wanted to transfer control of the company to someone else, then new directors can be appointed and others removed.  If you are looking to take on investment or new partners then a company would be a good way to achieve this.  It also offers you the ability to transition your business to the next generation if you want to keep it in the family.

If you still think a company is the right move for your business, or you have more questions after reading this, then please contact us so we can help you make the right decision.  We can set up a free consult to discuss your situation and work through these considerations whenever you’re ready.