When setting up small businesses, many entrepreneurs and business owners immediately look to register new companies and complex company structures to facilitate the business. This desire stems from the understanding that setting up a company as a separate legal entity assists in protecting the business owners and protects a business’s owners’ personal assets.
This is true, but it is a misnomer that all business owners should be setting up companies to run their business. This is because many of the perceived advantages are not as strong as many people believe, and the company structure is much more heavily regulated and costly which could offset any of these perceived advantages.
The complications of the company structure
The first misleading element of corporations are that they are separate legal entities which are completely distinct from the individuals who operate them. Whilst the legal construction of the ‘corporate veil’ is present in the creation of a company, there are many mechanisms which are now available which offset this notion. Notably, the Corporations Act is now regulated in such a way that directors, the individuals who operate the company, have a number of significant obligations, which are highly regulated, and for which breaches carries serious, personal penalty.
It is also commonplace for directors to be required to provide ‘personal guarantees’ for the company when entering into any type of contract. From the photocopier lease to the company credit card to a mortgage, guarantees are a requirement, completely undermining the benefits that the distinct corporate structure provides.
In addition, other important federal legislation attaches personal liability to directors of companies for breaches, such as ‘accessorial liability’ in the Fair Work Act and directors’ penalties in Workplace Health and Safety laws.
It is also misleading that corporations enjoy taxation advantages, because whilst they enjoy lower income tax rates, they do not enjoy the same tax treatment as individuals in areas such as CGT and land tax.
Finally, the Corporations Act also provides liquidators with enormous and extensive powers to investigate the affairs of companies that are being wound up or suspected of trading whilst insolvent. In many cases, a business owner may not even be aware or realise when they commit breaches of the Act which can be further penalised in a business owners’ personal capacity.
Alternatives to the company structure
When a business owner weighs up the cost of registering a business and paying the relevant fees each year to operate their business, they should be weighing up those costs, along with the above issues against the perceived benefits of the corporate structure to determine which structure is of most benefit.
For example, a business owner may opt to operate as a sole trader, or in partnership with another. As mentioned above the distinction between companies and individually run businesses in terms of their liability and exposure is not as removed as one might perceive, and individually run business can operate at a significantly lower cost, and with significantly less regulation and obligation.
It should be noted that an individual who trades solely and who carries the risk of the business’s profitability themselves may then put themselves at the risk of bankruptcy and the pursuits of a trustee appointed in bankruptcy who would play a similar role of a liquidator. Although, the liquidator’s powers under the Corporations Act are more expansive than a trustee in bankruptcy.
This is not to say that the company structure is now irrelevant. In many cases, the business, its goals and the owner’s situation will dictate that a company is still preferable. However, a business owner should always consider the other alternatives rather than taking the company set-up as a fait accompli, and if they do set up a company, understand the requirements, obligations and the exposure for their financial situation at the time.
When setting up these structures, it will always be preferable to obtain both accounting and legal advice to determine the best structure for you.