Structure impacts sustainable profits

Structure plays significant role planning wisdom.

Structure is required to grow profitably and sustainably

Have you thought about the advantages of the various business structures? Should you form a limited liability company and how do you go about it? Not sure if you need to create a not-for-profit organisation, or an Indigenous corporation for your type of activities, or remain a sole trader? There is no doubt that having a good structure impacts profitable growth and sustainability.

Designing an organisation structure helps you identify all the critical parts of the business. Planning the structure also helps to ensure there are enough resources to accomplish your plans. It is also important that responsibilities for each part of the structure are clearly defined. Each person must have a clear function or job description that outlines their responsibilities. Each job occupies its own position in the structure and how it relates to the other parts.

The following gives you some answers to the most frequently asked questions regarding the incorporation of your business, or organisation. Remember that actual types of structures vary from country to country. Therefore, anyone dealing with multiple countries will find it pays to always seek professional advice.

Often in smaller organisations, people do not always like what they are doing or are doing what they are good at. Therefore they have little regard for the rest of the operating structure.

Important notes:

  1. Irrespective of the type of business structure you choose, you should speak with your accountant and tax professional. If only to determine what business structure will be the best for your particular circumstances.  Many businesses are not incorporated, which shows they are either receiving bad advice or have too much belief in their own understanding of business.
  2. Another important foundational aspect of your business is your website and how it interlinks with social media and content marketing. The following website will give you an idea of what could be utilised in the foundation of your marketing. http://goo.gl/IbKe89 

Different ways to structure your organisation

  1. Sole trader.
  2. Partnership.
  3. Limited Liability Company.
  4. Co-operative.
  5. Public Company.
  6. Not-for-Profit Organisation.
  7. Indigenous corporation.

If you’re ready to incorporate a business, the simplest way is to set up a Limited Liability Company. It gives you the ability to create a separate legal entity for your business which separates you as the owner, from the business. This gives you a level of protection, by allowing you to separate and protect your personal assets from those of your business.

Other structures such as a Trust, Co-operatives or Associations consist of organised groups of people who share a common interest, activity, or purpose. It is always advisable to seek professional advice.

What are the advantages of a legal structure?

The main reason to structure or incorporate is to minimise your personal liability. Once your business is incorporated, it exists as a separate business entity. Essentially, you put a wall separating your personal assets from anything in the business. Of course, there are other benefits too. Following are the top reasons to incorporate:

  1. Minimise your personal liability and protect your personal assets.
  2. Have more flexibility when it comes to taxes (talk to your tax advisor for specific advice on your personal situation).
  3. A legal structure boosts the credibility of your small business.
  4. A structure adds a layer of privacy, by not using your name or home address to represent your business.
  5. Start building your business creditability.
  6. Protection for your business name and brand.

What are the disadvantages of a legal structure?

A big disadvantage of a legal structure is the need to operate your business at a higher administrative level than you’re used to as a sole proprietorship. This is one of the reasons so many small business owners do not incorporate during the start-up phase or early growth phase. In addition, incorporating can result in higher taxes for some small business scenarios due to double taxation.

With a corporate structure, the business needs to pay taxes on any profits likewise the owners may also be taxed on any profits that are distributed to them. If you’re looking to put your small business profits into your own pocket, you may end up paying a lot of extra tax. However, there are ways to avoid double taxation while still receiving some of the benefits of incorporation.

Sole Proprietorship

A Sole Proprietorship is an individual in business by themselves are the most common form of business structure. This type of business is simple to form and operate and may enjoy greater flexibility of management, fewer legal controls, and fewer taxes.

However, the big downside for the business owner is personally liable for all debts incurred by the business. This should be avoided once the business is established because of the litigious society we now live in.

 Advantages

  • Easy and inexpensive to form: A sole proprietorship is the simplest and least expensive business structure to establish. Costs are minimal, with legal costs limited to obtaining the necessary licenses or permits.
  • Complete control. Because as the sole owner of the business, you have complete control over all decisions. You aren’t required to consult with anyone when you make decisions or want to make changes. This is usually how people get a business idea off the ground.
  • Easy tax compliance. Your business is not taxed separately, so it’s easier to fulfil the tax reporting requirements for this structure.

Disadvantages

  • Unlimited personal liability. Because there is no legal separation between you and your business. You can be held personally liable for all the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions, which can become onerous.
  • Hard to raise money. Sole proprietors often face challenges when trying to raise money. Because you can’t sell stock in the business, investors are reluctant to invest without a legal structure. Banks are also hesitant to lend to a sole proprietorship because of a perceived lack of credibility when it comes to repayments if the business fails.

Partnerships

A Partnership is usually composed of two or more persons who agree to contribute money, labour, or skill to a business. Each partner shares the profits, losses, and management of the business and each partner is personally and equally liable for debts of the partnership. Formal terms of the partnership are usually contained in a written partnership agreement.

This type of structure is to be avoided due to the personal and other risks involved. The personal risks occur when the partners grow apart. One thinks they are contributing more than the other. Including each partner being joint and severely responsible for the other’s mistakes and misjudgements. In other words, the creditors can go after the partner with the money. When new spouses or partners become involved further problems may arise.

Advantages

  • Easy and inexpensive. Generally an inexpensive and easily formed structure. The majority of time will be spent focusing on developing the partnership agreement.
  • Shared financial commitment.  Each partner is equally invested in the success of the business. It has the advantage of pooling resources to obtain capital. This could be beneficial in terms of securing credit, or by simply doubling your seed money.
  • Complementary skills. Good partnership benefits from being able to capitalise on utilise the strengths, resources and expertise of each partner.

Disadvantages         

  • Started for the wrong reasons.  Two friends get together because they liked working together in a bigger company. Or they lack the confidence to go it alone. Or maybe just because it seemed like a good idea at the time.
  • Joint and individual liability. Similar to sole proprietorships, partnerships retain full, shared liability among the owners. Partners are not only liable for their own actions, but also for the business debts and decisions made by other partners. In addition, the personal assets of all partners can be used to satisfy the partnership’s debt.
  • Disagreements among partners. With multiple partners, there are often disagreements. Partners should consult each other on all decisions, make compromises and resolve disputes as amicably as possible.
  • Shared profits. Because partnerships are jointly owned, each partner must share the successes and profits of their business with the other partners. An unequal contribution of time, effort or resources can cause discord among partners.

Limited Liability Company

A Limited Liability Company is a hybrid of a sole proprietorship/partnership, a corporation and a Public Company. This structure is very popular among small, medium-sized businesses and for good reasons. The Limited Liability Company limits the personal liability of the owners and does not require the formality and paperwork of the Public Company. This makes it a great choice for business owners that want liability protection. You don’t want to deal with exhaustive meeting minutes, compliance filings or other paperwork needed in a Corporation, or Public Company.

This structure is the most popular choice with small-medium business (SMEs)owners and solo entrepreneurs when it comes to incorporating. It does not have as many formalities or ‘red tape’. Like setting up a board of directors, hosting shareholders’ meeting, or dealing with many other regulatory formalities unless by choice. It is usually the cheapest form of incorporation.

Advantages

  • Limited liability. Members are protected from personal liability for business decisions or actions of the company. Therefore if the company incurs debt, or litigation occurs, the members’ personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means “limited” liability. Members are not necessarily shielded from wrongful acts, including those of their employees.
  • Less recordkeeping. Operational ease is one of its greatest advantages. Compared to a public company or corporation, there are much smaller start-up costs.
  • Sharing of profits. There are fewer restrictions on profit sharing within, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat equity. It’s therefore up to the members themselves to decide who has earned what percentage of the profits or losses.

 Disadvantages

  • Limited life. In many cases, when a member leaves, the business is dissolved. The remaining members must fulfil all the legal and business obligations to close the business. The remaining members can decide if they want to start a new company or part ways. However, you can include provisions in your operating agreement to prolong the life of the company if a member decides to leave.
  • Self-employment taxes. Members of a company are considered as employees and must pay tax contributions. The entire net income of the company is subject to this tax.

Corporation or Public Company

This choice of this business structure has more complicated tax and regulatory filing requirements. However, it can be an ideal choice for certain types of businesses with certain business goals. It is ideal if you don’t want any restriction on the number of shareholders as they grow.

One of the best things about entrepreneurship is the way it enables you to adapt and evolve as your interests and the needs of your markets change. Incorporating a business in this way is often the second step when the company becomes established. Even if you’re not sure of which business structure to choose, you don’t have to fear you are making the wrong decision.

Advantages 

  • Limited liability. When it comes to taking responsibility for business debts and actions of a corporation. Shareholders’ personal assets are protected and can generally only be held accountable for their investment in the stock of the company.
  • Ability to generate capital. Corporations have an advantage when it comes to raising capital for their business. They have the ability to raise funds through the sale of shares (stock) in the stock market.
  • Corporate taxation. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends.
  • Attractive to potential employees. Corporations are able to attract and hire high-quality and motivated employees. This is because they offer competitive benefits, more resources and the potential for partial ownership through stock options.

Disadvantages 

  • Time and money. Corporation compliance work is costly and time-consuming. At the start-up and during operation. Incorporation requires start-up, operating and tax costs that most other structures do not require.
  • Double taxing. In some cases, corporations are taxed twice. First, when the company makes a profit and again when dividends are paid to shareholders. Franking of shares can go some way to elevate this.
  • Additional paperwork. Corporations are highly regulated by federal, state, and in some cases local governments. There is increased paperwork and recordkeeping burdens associated with this entity.

Not-for-Profit organisation

A not-for-profit is created for charitable, educational or other purposes. There are five recognised purposes: charitable, religious, scientific, educational, sporting and literary). Not-for-profits cannot benefit the owners. All money above operating costs (profits or surpluses) must be used to further the goals of the not-for-profit. This allows not-for-profits to operate tax-free. Approval is needed from governments to operate such a structure.

Just as other structures, a not-for-profit corporation offers a shield that helps protects the personal assets of the not-for-profit’s stakeholders. In most cases, as long as the legal structure remains correct, stakeholders of not-for-profit corporations are immune from individual liability.

When is the best time to incorporate?

In most cases, it’s best to incorporate or form a company as soon as possible. The main benefit is liability protection and by waiting, you can be exposing yourself to liability. Keep in mind that your corporation’s start date is not retroactive.

How to structure and incorporate?

There are three common methods for incorporating. Each has its pros and cons, depending on your needs:

  • Accountant or lawyer: This is the most expensive option, but is usually necessary for most situations. For example, if you have complex requirements for how your shares (stock) should be allocated or will be, or are working with millions of dollars. Then you should always seek expert advice.
  • Do-it-yourself: DIY is the lowest cost method, but you’ll need to do everything yourself. This is the best option only if you’re more interested in saving money than time. When taking this option  you need to be able to deal with lots of details and legal requirements.
  • Online legal filing service: This option is slightly more expensive than DIY. An online legal filing service will complete and file the documentation for you. But like any legal document, the articles of incorporation and application are full of tedious details. A professional service can make sure that your application is done properly and processed smoothly.

Important note: Irrespective of the type of business structure you choose. You should speak with your accountant and tax professional to determine what business structure will be the best for your particular circumstances.

Where should you incorporate?

You often hear of companies incorporating in other states or countries. This is because they offer flexible, pro-business statutes, as well as tax incentives.

However, as a general rule of thumb, you should incorporate in the state where you live or, where your business has a physical presence. When you incorporate in a different place from your physical presence, you’ll need to deal with added fees and paperwork. This for most small businesses isn’t worth the added hassles.

Structure may include personal guarantees

Over the years, I have helped many clients avoid the risks of signing a personal guarantee. Signing a personal guarantee gives creditors the right to pursue your personal assets if your business defaults. Even before the business assets are liquidated. Creditors tend to act quickly without fear or favour, they want their money.

You always tend to think the risks are not that big and you can handle them. This is particularly so when you are anxious to get your hands on some new money to take the pressure of cash flow.  You have probably heard these lines. “A personal guarantee is no big deal; it’s just a requirement of the bank”. “Everybody signs it, it’s nothing to lose sleep over”. “We never sue unless we think we’re being deceived or defrauded and I sure you won’t be doing that, will you”. Who’s kidding who?

When a personal guarantee is called in, you will pay dearly in sleepless nights, guilt, and shame. The emotional strain can last for many years, particularly if there is a marriage breakup.

You shouldn’t put your home on the hook without telling your spouse. You’d be amazed how many businessmen don’t tell their wives when they do this. The best thing is to avoid personal guarantees, at worst at least insure against them.

Quotable quotes

“Definition, rationality, and structure are ways of seeing, but they become prisons when they blank out other ways of seeing”. A.R. Ammons

“If we can by any method establish a relation of mutual trust between the labourer and the employer. We shall lay the foundation stone of a structure that will endure for all time”. Mark Hanna

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