Guest Post From A Technology Lawyer: Which Australian Business Structure Is Right For Your Startup?

Guest post by Dudley Kneller: Dudley is a technology lawyer with a speciality in startups, cyber risk and strategic sourcing and supply projects. He has more than 18 years’ experience practising across Australia, Europe and the UK, and has worked on projects based in a range of countries, including the Philippines, India, and Russia and throughout South America.

With so many other competing priorities, it is not a surprise that many startups struggle to decide on an appropriate structure for their business.

It can be a challenge to find the time to navigate the information available and choose the best structure for you, your partners, investors and customers.

This post will break down the 4 most common business structures available to Australian startups, and look at the pros and cons for each structure so you can start assessing which makes the most business sense for you and your partners.

These structures are:

1. Sole trader

2. Partnership

3. Company

4. Trust/joint venture

Why is choosing a business structure so important?

Your business structure will have an impact on:

• How much tax you pay
• Whether you’re legally considered an employee or the owner
• Your personal liability
• How much control you have over the business
• Ongoing operational costs and expenses

Choosing the right structure will save you many headaches down the track, allow you to raise capital more easily and protect you and your business partners as long as you get it right.

What are the ‘must haves’ for startup business structures?

In my experience, most startups are looking for the following headline “must haves”:

1. Easy set up
2. Low establishment and ongoing costs
3. Limited liability
4. Effective tax arrangements
5. Attractive to investors and customers; and finally
6. Startup friendly but flexible for when my business grows.

1. Sole Trader

Establishing your startup as a sole trader business means you will be operating the business in your own name and you accept full legal responsibility over all aspects of the business.

Pros

• It’s easy to set up and can be established very quickly.
• A sole trader is very much in charge of their own destiny and has ultimate control over the business.
• If you’re startup is still at “hobby” stage it allows you to keep on working your day job while it grows.
• Profits (and losses) come back to you as the individual owner.
• It’s relatively easy to change from this business structure as your startup grows

Cons

• As an individual you will be taking on all the risks of the business and any liabilities which it incurs.
• If the business generates any reasonable income you will quickly find yourself paying tax at the top marginal rate. You use your own individual Tax File Number to lodge tax returns (Read more about tax obligations for sole traders here).

If you are a startup with grand plans to conquer the world, expect to grow quickly and likely need the help of others to achieve this, then you may need to consider other options…

2. Partnership

A partnership is a group of individuals/entities carrying on a business with a view to profit, but not as a company.

Pros

• Like the sole trader option it is easy and relatively inexpensive to establish.
• Formal documentation can be kept to a minimum although it is advisable to set out the rights and obligations of each of the partners in a partnership deed.
• There are some tax “swings and roundabouts” for partnerships with a mix of advantages and disadvantages alike for partners.

Cons

• Profitable partnerships can push their individual owners into higher tax brackets unless additional structuring advice is sought at the outset.
• You and your partners are personally liable for any and all debts of the partnership.
• Less control over the business as a whole (although shared management may be considered a pro depending on your personal viewpoint!)
• You must be registered for GST if your annual income turnover is over $75,000.

The partnership agreement can vary the allocation of profits and losses depending on the relevant contributions from each of the partners which does provide a measure of flexibility.

From a startup perspective you will want to be very confident in your choice of partner as partners are jointly and severally liable for the debts of the partnership.

Therefore, each partner’s own assets are potentially at risk in a partnership.

For a startup whose principal asset moving forward is (hopefully) its intellectual property assets, partnerships can prove a challenge. Potential investors are keen to ensure “clean” ownership of assets and partnerships can sometimes muddy these waters.

3. Company

Of all the various options available, setting up as a company provides your startup with the greatest amount of flexibility and options. A company structure sets up a separate legal entity which is able to own assets and enter into contracts directly with third parties.

Pros

• It is separate from its individual shareholder members which limits the liability of these members from any losses the company may incur. This ability to limit liability exposure is one of its main advantages over other structures.

• Companies are subject to different taxation requirements than those applying to you as an individual. The current company tax rate is 30% which compares favourably to the higher marginal tax rates applying to individuals under the Sole Trader structure.

• As a startup you will have the ability to take advantage of favourable tax incentives and grants made available by State and Commonwealth governments. See various grant options available here and here for example.

Bonus: Top 8 Government Grants For Startups

• Appeals the most to investors and will therefore allow you to bring on new investors more easily.

This can be done in a variety of ways including by issuing shares to these investors in return for capital or taking funds on through loan arrangements directly with the funder. There are other options available too as arrangements become more sophisticated including via convertible notes, etc. Cons

• Companies do take a bit more effort to set up.
• There are higher set up costs associated with incorporating the new entity as well as ongoing compliance costs.
• Running a company will require that you to become familiar with various tax and legal reporting obligations and requirements. Whilst the additional reporting obligations is something your accountant and lawyer can assist with, it nevertheless needs to be factored into your planning.

• Has the biggest loss of control. Business operations are controlled by directors, but ultimately owned by shareholders.

A word about shareholder agreements

You have the ability to set out in some detail the rights and obligations of founding shareholders in a shareholder agreement.

This document provides a roadmap for you to follow.

It can deal with member share allocations, decision-making, roles and responsibilities, new investors, sale of the business, etc.

It can provide mechanisms for managing disputes and can provide a blueprint for any restructuring activities which may become necessary as the business grows and takes on more investors or expands overseas.

Whilst you are unlikely to be hiring employees right from the get go, as you expand you will want to take on staff directly to supplement your contractor workforce.

A company structure allows this to occur seamlessly without increasing your individual legal exposure to the increased financial and other obligations associated with employees.

4. Trust arrangements and joint ventures

A trust is an obligation imposed on an individual – a trustee – to hold property or business assets for the benefit of others, known as beneficiaries.

There are a number of different “flavours” of trust and joint venture structures all with various advantages and disadvantages.

Pros

• Trusts and joint venture arrangements are relatively easy to set up and operate.
• There are some particular complexities with trusts including legal obligations which will require ongoing advice.
• Trust arrangements do have tax benefits worth exploring however.

Cons

• Requires a formal trust deed that outlines how the trust operates.

Joint venture arrangements are generally not seen in traditional startup businesses, unless of course you are a junior miner hunting for gold or oil in outback Australia and need a few partners to share the risk!

Which one should you pick?

I would expect to see most serious startup businesses setting up as a company, perhaps separating out the intellectual property assets from the main operating company.

Companies can also consider to what extent trust arrangements can play a part in assisting to manage liability and tax issues efficiently for the individuals involved.

For each individual business this will vary depending on the particular objectives of the business and its founders.

If your startup is planning on raising seed or venture capital investment, I would definitely recommend setting up as a company before you hit the investment circuit.

Bonus: The App Developer’s Investment Pitching Kit

It is clear that if you are serious about your startup business and are prepared to commit to some of the ongoing compliance requirements, then a company structure is your best bet.

This structure will likely offer you the greatest flexibility as your business moves from napkin, to garage, to boardroom and finally to exit.

For more information on each of these 4 business structures, visit the Australian government website.

Where to go next

Template: Profit And Loss Forecasting For App Startups

The Information Memorandum Investors ACTUALLY Want To Read

What Startups Need To Get Done Before Seeking Investment Funding

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