In Short
- Companies: The limited liability of a company makes it attractive for investors, as shareholders aren’t liable for company debts.
- Partnerships: Investors may be deterred by unlimited liability, as all partners are personally responsible for debts.
- Trusts: While providing asset protection, trusts can’t retain profits for growth, often less appealing to long-term investors.
Tips for Businesses
Choose a structure that balances investor appeal and liability. Companies typically attract investors due to limited liability, while partnerships and trusts may pose financial risks to individuals. Evaluate each structure carefully to align with your growth and funding goals.
When deciding what business structure to create and operate your business through, a crucial consideration should be whether that structure is attractive to investors. Changing your business structure after you raise capital can be very difficult. In many cases, your shareholders will need to agree to any changes. Changes to structure also inevitably affect the rights of shareholders and may come with various tax complications. It is important to consider all possible options before making a decision. This article will discuss the various types of structures and their attractiveness.
Raise Capital as a Company
A company is a separate legal entity from its directors and shareholders. Companies can act like a natural person, meaning they can enter contracts, own property, sue and be sued. Generally, when the company incurs a debt, it is the company’s to pay as opposed to its directors or shareholders.
Asset protection is one of the main benefits of running your business through a company. Directors of a private company limited by shares are generally not liable for their company’s debts. As the company is a separate legal entity, the company’s debts are the company’s to pay. Here, an investor who appoints a director to the board will not be liable to pay the company’s debts unless there is a breach of directors duties on that director’s part.
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Further, shareholders are generally not liable (or legally responsible) for company debts. As a shareholder, you are only legally responsible for any amount unpaid on your shares.
The limited liability afforded by a private company in Australia is the most attractive structure for investors. If the business does not work out and the company has to wind up, investors will generally not be liable to pay the company’s debts.
Raise Capital as a Partnership
All partners jointly own the business and its assets in a partnership structure. However, this also means every partner is equally responsible for the business’ debts.
An advantage to operating through a partnership is that when the business makes a profit, the partners share in the profit in their respective ownership proportions. Likewise, they pay tax at their personal income tax rate. However, the same principle applies to losses. If the business makes a loss and owes debts to one or more third-party creditors, each partner is liable, in their respective ownership proportions, to pay the debts.
Each partner also carries unlimited liability. So, where your business incurs a debt, each partner has unlimited liability concerning that debt. Accordingly, partners may need to use their personal assets to satisfy the debt. No matter how large the debt is, you will be personally liable to pay it off.
A partnership usually requires the investors to become partners. This may be attractive to investors because they have an equal share of the profits. However, they will have an equal share of the losses. If there are losses, other investments that the investor owns may be at risk to satisfy the partnership’s large debt. That reason alone makes partnerships highly unattractive to investors.
Continue reading this article below the formRaise Capital as a Trust
A trading trust is a business structure that involves a trustee who owns the business assets and enters into contracts on behalf of the trust. The trustee is an entity that can either be an individual or a company.
The trustee is commonly a company, meaning you benefit from a company’s limited liability and asset protection.
To illustrate how a trading trust works, suppose you run your business through a trading trust. Company Pty Ltd is the trustee of the Trust. If you want to hire John as an employee, Company Pty Ltd, as trustee of the Trust, will enter into the employment agreement.
Similarly, if you want to purchase assets for the business, Company Pty Ltd will purchase them and own them on behalf of the trust.
A trust is conducive to investments. However, it is not the preferred structure for most sophisticated investors. The trustee must distribute profits held in the trust assets at the end of the financial year. Otherwise, the trust will be taxed at the highest marginal rate. Consequently, a trading trust cannot retain profits to grow the business from year to year. This may turn investors away as they will likely want to be in the business in the long-term. If the business cannot retain profits and use them for growth, that is not ideal if you are looking for investment.
Key Takeaways
There are different structures you can operate your business through, although not all are suitable if you want to raise capital and grow your business. A company is the safest structure and is the most common when looking to raise any amount of capital. You must also consider other considerations, such as tax advantages and operating costs. Still, a company is a great structure to set up from the start.
To discuss which business structure is the most attractive to attract investors and raise capital, our experienced capital raising lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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