There are a number of structures to consider when purchasing an existing franchise or setting up a new one. These include: operating as a sole trader, a partnership, a company, a two-tiered company structure or through a trust. This article considers the advantages and disadvantages of each when operating a franchise.
Setting up a proprietary limited company to operate a franchise will protect your personal assets, as a company is a separate legal entity. It is capable of owning its own assets and liabilities and entering into contracts on behalf of the franchise.
It is a more straightforward structure to operate than a two-tiered company or a trust, as you would generally have a single set of accounts and regulatory requirements to meet. The potential disadvantage of having a single company operate a business is that generally all of the valuable assets and intellectual property of the business would be at risk if the company were to fall into difficulties. If you needed to wind up the company for one reason or another, you could potentially lose all of the assets of the business. This is important to consider if you want to have these assets for future use.
In the case of a franchise system, it is common for the franchisor to be the owner of the intellectual property of the business and to license this to your company for use in operating the franchise. This means that these more valuable assets of the business would not be owned by your company, and so would not be at risk if your company fails.
Some businesses decide to set up a two-tiered company structure to protect the valuable assets of the business. This is usually done through a holding company and operating company relationship.
The holding company owns the assets and intellectual property of the business and the subsidiary company is the operating company. This means that the subsidiary company is the entity that enters into contracts and incurs liabilities. It does not own any assets of the business.
If a third party sued the operating company, the assets of the business would generally be protected because they are owned by the holding company. There are exceptions to this, however, so it is important to discuss this with a legal professional. Some other advantages can include tax and investment benefits which should be discussed with your accountant or financial advisor.
The main disadvantages of this structure are that it is expensive to set up and manage, as you need to have clearly separated accounts and records. You will also need legal agreements in place between the companies for the licensing of any intellectual property or loan arrangements.
As mentioned in the above section, in a franchise relationship, generally the franchisor is the owner of the valuable assets of the business; so operating a franchise through a two-tiered structure may be unnecessary in these circumstances.
Franchise Trust Structure
The final structure to consider operating your franchise through is a trust. There are two different types of trusts, discretionary (family) or unit trusts. With either trust type, there is a trustee that owns the assets of the business and operates the business on behalf of the trust.
A discretionary trust allows the trustee to choose how to distribute the assets to the beneficiaries of the trust. A unit trust is different in that the trustee doesn’t have the choice in how it wants to distribute the assets. The beneficiaries of a unit trust own a set amount of units and receive a set amount of the distribution based on this.
With a trust, the trustee is the legal entity, not the trust itself. A trustee can be an individual or a company. The advantages of a trust are that there are tax and asset protection benefits. These should be discussed with an accountant to see how this would affect your particular circumstances.
The disadvantages of a trust are that it is more expensive to set up than a company, particularly if you also want to set up a corporate trustee. The trust must distribute the profit/income of the trust to the beneficiaries each financial year to avoid paying the highest tax rate. This can be a problem if your business needs working capital or wants to attract investment to grow the business.
Whether or not a trust structure will work for your franchise will depend on what your business plans are, how much working capital the franchise requires to operate and how long you want to be in the franchise for.
Issues to Consider
Now that you know the structures available to you, it is important to consider your particular circumstances and other requirements specific to the franchise you wish to purchase.
For example, while there are benefits of operating a franchise through a company, franchisors often require franchisees to enter into a personal guarantee. This is to effectively get around the personal asset protections of a company. This means that you would be personally liable in your dealings with the franchisor. Despite this, a company structure would still provide personal asset protection in your dealings with third parties, such as customers or suppliers.
If you wish to set up a company to operate your franchise, it is also important to consider how you will own your shares in that company. You can own your shares individually, through another company or a trust. Discussing this with an accountant will help to understand the tax implications of each personal ownership model.
The Ultimate Guide to Setting Up a Franchise
Making the decision to franchise your business can be difficult. This Franchisor Toolkit covers all the essential topics you need to know about franchising your business.
This Toolkit also contains case studies from leading franchisors including leading Australian franchises including Just Cuts, FlipOut and Fibonacci Coffee.
Speaking to one of LegalVision’s specialist business structures solicitor on 1300 544 755 will help to determine which structure would be more beneficial for you in a legal sense, based on your specific circumstances.
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