Running a small business: Ins and outs of who owns what

WADE GLASS and GARETH HOOLE continue their series on how to start up and run your own business.



We have discussed issues to consider before you decide whether to go into your own business and examined three possible types of businesses.

Now you need to decide on the legal structure and how that business will be owned.

When choosing an appropriate structure for a new building, an architect considers the environment around the building, its intended purpose and even likely escape routes should disaster strike.

You must apply these same principles when considering the business structure best suited to your needs.

The most suitable structure depends upon applicable legislation, how the stakeholders wish to manage the business, future succession, risks and the ever-present and all-important Inland Revenue Department.

The current legislative environment allows businesses the choice of four broad structure categories, outlined in this table.

This table probably prompts more questions than answers.

An appropriate structure should be decided by consultation with your professional adviser.

The individual circumstances of each business owner requires due consideration before the business begins.

These different business entities will bring particular rights and obligations under a variety of legislation. You will need to have a broad understanding of these business laws, as you make the necessary decisions in the day-to-day running of your business.

It is essential that you seek sound professional advice at this stage. We have referred to specific legislation in the above table but there are many more laws to consider. We shall address this in a future article.

The business structures need to be considered in terms of your own particular risk profile.

For instance, how much personal liability are you willing to bear? How much control do you want the other parties in the organisation to have? Is succession planning a consideration at a later stage (ie do you want to pass the business on to your children or certain employees)?

Taxation

Taxation can be a significant expense with serious cashflow impact so it is not surprising it is paramount in the minds of the owners of small to medium-sized enterprises (SMEs).

The initial structure of your SME will affect the taxation efficiency of your business and without having sound tax planning at the outset, you may encounter a disaster in the future.

Everyone is in business to make money, but there is nothing more frustrating than finding out you cannot extract your money from your business without paying more tax on it.

Finding your taxation "best fit" means analysing your business and personal affairs, both current and projected, and building taxation issues into your overall business strategy.

Other issues

The nature of your business and your overall business strategy is of paramount importance. Your business structure must reflect this.

If you expect the business will grow substantially in its early years, how will you fund the growth?

Will it be in the form of debt or equity? Equity funding is where other people invest in your business by buying some of the shares or an issue of new shares.

As shareholders in your business they will have certain rights, so you must be aware that with a new shareholder you may have less control over the business than you would prefer.

On the positive side, the new shareholder/s may bring specialist skills to the business that were previously lacking.

We recently assisted a start-up business venture. The owner, an experienced entrepreneur, had limited financial capital and less time available than was necessary to operate the business.

He was able to bring a trusted family member into the business by giving him shares in the new company. In return, the family member committed vital dollars and time to ensure the necessary attention was given to the business.

Should you wish to retain control over the activities of the company (and all the profits to yourself!) then debt funding may be more appropriate.

Of course, you will need to convince the banks you can service the loan, and they may impose some form of lending covenants (restrictions) on your business.

Companies are the preferred vehicle where additional equity is required as they are accepted as the most popular entity, offer significant flexibility and liability limitation. Conversely, trading under a trust structure does not allow much flexibility and any major changes usually result in additional professional fees.

Unsurprisingly, the most common form of business ownership is the limited liability company and unless there are very good reasons against it, this should be your preferred legal structure.

A company provides its owners - the shareholders - with the benefit of limitation of liability.

They can only lose what they have contributed by way of capital. This is a cornerstone of company law.

However, there are circumstances where such limitation of liability is voided, such as when personal guarantees are given, or it can be demonstrated that the rules of governance as stipulated in the Companies Act 1993 have been breached.

The personal assets of a company director may be at risk where the requirements of the Companies Act 1993 have been breached.

The matter of how you structure your business, and your underlying ownership in it should be decided before you begin to trade.

Businesses within New Zealand are presented with a plethora of opportunities and challenges that were not available two or three decades ago.

Globalisation and the emergence of e-commerce (internet-based transactions) mean the New Zealand business community is less insulated from events that occur overseas.

Your business structure should take these modern commercial trends into account.

If you plan to trade globally, whether directly or on the internet, you should choose a business structure that allows flexibility with regard to international taxation issues and risk minimisation.

* Wade Glass (assistant manager) and Gareth Hoole (associate director) are chartered accountants in the Corporate Recovery Services unit of Staples Rodway, Auckland. The views expressed are their own and not necessarily those of Staples Rodway.

TOMORROW

Business viability assessment and forward planning.

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