Embarking on the entrepreneurial journey is thrilling, but it also comes with a need to make a multitude of decisions. One of the most important decisions to consider when starting your business is the various business structures that are legally available to you. In this article we explore the pros and cons of a company vs a trust structure, in the context of a for-profit business.
In Australia, the two most common vehicles for startup structures are companies and trusts. Making the right decision depends on your business and personal goals, and your specific circumstances. If you’re not sure how to structure your business, our expert accountants and lawyers are here to school you on the differences between a company and a trust, and how to make the right decision.
Structuring Your Business as a Company
When it comes to structuring your business as a company , you can be a public company or a ‘proprietary limited’. As a startup or small businesses, you’ll be starting life as a proprietary limited company. This is a privately owned entity with share-based ownership, the company is restricted to a maximum of 50 shareholders and cannot be publicly traded on a stock exchange, preventing the general public from purchasing its shares. A proprietary limited company structure ensures that shareholders' liabilities are confined to the amount invested in purchasing the shares, shielding them from further financial risks. In other words, shareholders stand to lose only the capital they initially contributed to acquire the shares.
Benefits of a Company Structure
We have a real-life example of a BlueRock client who had an amazing, entrepreneurial idea for a new software solution, but needed capital to spend on researching and developing the solution. The right decision for the client’s startup was a company because in a company structure, it was easier to raise capital and they could take advantage of tax benefits such as the 25% income tax rate and the R&D Tax Incentive !
There are several reasons why a company structure is a popular choice for startups. Let’s dive into some of them below.
Limited Liability
One of the main advantages of a company structure is that it provides limited liability, meaning the personal assets of the owners are typically not at risk if the company encounters financial difficulties. This separation between the business assets (and risks) and personal assets can provide peace of mind for founders, who are often shareholders too, and future investors.
Perpetual Existence
A company also has a life of its own! And the life of a company will continue until it’s formally wound up and de-registered. This can provide continuity and stability, which can be beneficial for long-term business planning, growth and multi-generational succession or eventual sale. While trusts are similar in terms of longevity, in most Australian jurisdictions they will have a maximum lifespan of 80 years.
Third-party Investment in Your Startup
If you're looking to attract investment for your startup , going with a company structure is the way to go. Investors, especially venture capitalists (VCs), are mainly interested in putting their money into companies, not trusts. Companies offer limited liability protection and the flexibility to buy and sell shares, which VCs love. On the flip side, setting up as a unit trust can seriously limit your access to future capital.
But it's not just investors who prefer companies. Clients, customers, and suppliers also feel more at ease dealing with a business that's regulated by official bodies. Going the company route adds credibility and trust, making those interactions smoother and more successful.
Tax Benefits
Companies in Australia pay tax at the corporate tax rate, which generally leads to a lower effective tax rate than for individuals, especially as your profits increase. Tax rates for companies can be 25% or 30% depending on the size and activity of the company. Most companies carrying on an active small business will be taxable at the 25% rate.
Comparatively, an individual can pay tax up to 47%. In addition, Australian companies may be eligible for a range of tax concessions and incentives, including those for research and development .
Access Grants & Incentives
As we touched on with our client example, accessing government grants and incentives such as the ESS startup tax concessions , ESIC tax incentives , R&D tax incentive , and many more, is only possible for registered companies.
Structuring Your Business as a Trust
A trust can also be a viable option for a startup in Australia, particularly if the business has multiple stakeholders or if the founders wish to protect their assets.
One of our clients is a family-run fruit grocer with multiple family members working in the business. The family members were beneficiaries of the trust. From an accounting perspective, this made it flexible and tax effective to distribute income to the family members. From a lawyer’s view, however, the choice of whether to structure a startup as a company or a trust will depend on the specific circumstances and goals of the business.
Trusts can provide tax benefits, flexible profit distributions, asset protection and confidentiality, but they can also be more complex to set up and manage than companies. Let’s dive deeper.
Flexibility to Distribute Income
A benefit of trusts, particularly discretionary trusts, is that the trustee has the power to decide how to distribute the trust income among beneficiaries. This flexibility can be beneficial for startups because it allows for the strategic distribution of profits to minimise taxes and support business growth over time.
Legal Protection
In a trust structure, the assets are owned by the trustee on behalf of the trust, for the benefit of the beneficiaries. This separation can shield trust assets from claims against the beneficiaries, such as personal debts or legal disputes.
Personal Privacy
Trusts offer a higher level of privacy compared to other business structures. Details about the trust, including the identity of beneficiaries, are generally not required to be publicly disclosed. This can be beneficial for startups that prefer to maintain confidentiality around ownership, financial arrangements, or sensitive commercial information.
Holding Company Shares in a Discretionary Trust
Now, let's talk about the benefits of holding your shares in the company through a discretionary trust (not setting up a unit trust).
What is a discretionary trust?
Think of a trust as a legal relationship rather than a physical entity. It's established through a legal document called a trust deed. The trust holds assets (like shares in your company) for the beneficiaries' benefit. Practically speaking, this means that founder assets are safeguarded within the trust. When there are dividends or a startup sale, the trustee can control how the funds flow to the beneficiaries and unlock potential tax benefits.
Benefits of holding company shares through a discretionary trust
- Tax planning: By distributing the yearly income to beneficiaries, a trustee can minimize the amount of tax paid by the trust. Since beneficiaries usually earn less than the trust's income, they can be taxed at lower rates, resulting in tax savings.
- Asset protection: Here's an example to illustrate this benefit. If an individual faces bankruptcy, debt issues, or personal lawsuits, assets held in a trust are generally protected. These assets are legally owned by the trust and are not considered part of the individual's personal property or assets.
By utilising a discretionary trust to hold your shares, you can enjoy tax advantages through income distribution and safeguard your assets from personal liabilities. It's a smart strategy that combines the benefits of a trust structure with the operational advantages of a company.
Company or Trust? Our Verdict
When it comes to structuring a startup as a company versus a trust, we recommend opting for a proprietary limited company. While we acknowledge the advantages of utilising a trust, such as income distribution flexibility, legal protection, and personal privacy, we suggest attaining these benefits by holding shares in the proprietary limited company through a discretionary trust. This approach allows startups to harness the advantages of a trust while benefiting from the stability and advantages offered by a company structure.
Get Help Structuring Your Business
It's best to consult with a lawyer and an accountant to determine which business structure is best for your startup based on your specific circumstances and goals. Lucky for you, at BlueRock we have both! Get in touch to book a consultation on startup structures with our business advisors today.
