If you are in a small business, you recognise the importance of structure. It’s the backbone of what you are trying to accomplish. Structure is apparent in many different ways in a small business, but one of the most important is the legal structure in which it exists.
In this article we will begin by looking at the small business structures themselves, then we will look at small business funding through such structures.
Small business ownership structures
A variety of legal structures can be used for the operation of a small business and the ownership of its assets. In fact, those two things can even be separated into two different structures!
Self-employed sole traders
The simplest structure is self-employed people working as sole traders. They operate under their own name (or a trading name owned by themselves as individuals), get an ABN and they are off and racing. Setup costs are minimal, but at times it can be a challenge keeping business activity separate from personal activity and there is no protection from keeping the small business separate from the individuals involved.
Small business in a company structure
One of the most common structures used by those in small business is a company structure. Typically it will cost under $1,000 to set up and it gives a clear separation between the business owner and the business itself. From a risk management prospective there is a significant degree of protection, given that it is operated correctly.
Trusts in small business
A variety of trusts can be used for operating a small business and owning assets. For self-employed people looking to maximise the benefit for their family, a family trust is often used. All the income has to be distributed each year, at least in the accounts, but given that happens the trust doesn’t pay tax. Instead, each individual beneficiary receiving the income pays tax at their own marginal rates. Other types of trusts used in business are unit trusts and hybrid trusts.
Often a company will be setup to be the trustee. This basically doubles the setup costs, but it makes it function a bit smoother, gives a clear separation between trust assets and the individual’s assets and assists in estate planning issues.
Structures in small business funding
It’s not a problem for a company or a trust to be the borrower, although personal guarantees are generally going to be required from the company directors or trustees. The bigger question has to do with what the borrowing is for, and how that asset can be best held.
For risk management purposes it’s actually a good idea to keep major assets separate from the business activity itself. For example, a business premises could be owned by a lady. The lady leases it to a company business which has her husband as the director. The lady also owns the family home. In this situation if everything went pear shaped in the business, the properties should not be threatened. Of course the husband may have a problem if his wife sells everything and runs off to the Cayman Islands!
Should small business funding that is going to come from getting a loan against your family home or residential investment property, one approach is for the individuals involved to borrow against their home and then make a loan to the business themselves.
Sometimes a structure will be set up separate from the business for the purpose of holding major assets. That’s another way to compartmentalise assets for risk management purposes. It’s not a problem to get a loan against at least residential properties in such structures. Again, however, personal guarantees will be involved.
Personal guarantees in small business funding through structures
One might wonder if personal guarantees are going to make the risk management through the establishment of structures ineffective. That depends on what is guaranteed. If you are a tradesman and you provide a personal guarantee for the account set up with your major supplier, it means you will be liable for covering that account even if the business goes bankrupt. You are not protected from the financial claims from that supplier.
If, on the other hand, you have some investment properties held in a family trust separate from your small business and act as guarantor for the loan, it just means that you are responsible for making loan payments, no matter what. It should have nothing to do with someone trying to grab that asset if they are after something from you. How effective the trust is in protecting the asset will be dependent upon how it has been set up and the general flow of legal opinion at the time, but being the guarantor for the loan should not be the issue.
Small business and self-employed legal advice
We have clearly touched on many legal issues in this discussion. In so doing we have not come anywhere close in covering even the most important issues in making a decision about the use of any particular ownership structure for a small business or any other purpose. You can learn a lot more about such structures by reading the eBooks and articles in statecustodians.com.au/Legal. In addition you should see a lawyer to get advice for your own unique set of circumstances.
For learning more about loans secured by residential property that might be needed in your situation, speak to the credit managers at State Custodians Mortgage Company. They are knowledgeable and experienced in these areas and can give you assistance in setting up a suitable home loan or investment loan. Call them during NSW business hours on 13 72 62.