Are you considering switching from a sole proprietorship to a corporate structure?
There are so many good reasons to move your business structure from a sole proprietorship to a separate legal entity such as a corporate structure (Pty Ltd) from a legal, financial, tax and general perspective.
From a legal point of view, the main reason for moving from sole proprietorship to a business is to separate you as an entrepreneur from the business itself. If you are a sole proprietor, you are the company, so if the company were ever sued, it would be them against you. If the business is a hobby with no legal risk (or extremely low), then it might be good. But for most companies, they are not a hobby and they do carry a certain amount of risk.
Read on to learn about the benefits of moving your business structure from a sole proprietorship to a corporate structure. We list our top 3 advantages when choosing a business structure.
Why should you consider a corporate structure?
The question to ask yourself is: do you want to be sued personally? If that happens, all of your personal belongings could be “up for grabs.” Personal belongings, motor vehicles, possessions, property etc.
However, if you are setting up a company (eg Pty Ltd), you as the owner are usually only liable for the unpaid value of your shares.
As a director of that company, you still have fiduciary duties that you must fulfill at all times, for example, your duty to trade in solvents and act in the best interests of the company at all times, etc. Establishing and maintaining a company weighs far outweighs the legal protection afforded by a corporate entity.
Your accountant can give you financial/tax advice about the benefits of moving. They may advise you to switch to a Pty Ltd on June 30 of any given year. That is, the sole proprietorship ends on June 30, and the business begins on July 1. Normally there will be a little overlap between the two, but it is minimized when they are organized at the end of a fiscal year.
If you are a business that provides professional services to other businesses, you should consider including it as a means of protection.
There are many things to take into account, such as the assets of the entrepreneur(s). Every business should seek specialized legal advice and do so quickly.
Failure to take legal advice from the start could put the company at risk, exposing its assets and of course the company itself. You are basically playing “Russian Roulette” with the company to the point where you change the structure to reduce the legal risk.
Your business may have wheels in motion – it may have accumulated various intellectual properties, trademarks, domain names, company names, which need to be transferred to the appropriate entity as soon as possible.
Also, any contracts with suppliers or employees should be transferred to the new entity sooner rather than later. You should talk to your accountant about setting up a new Xero account separate from your sole proprietorship. It’s a complicated process, but when approached in a methodical way and with the right financial and legal advice, it shouldn’t be a daunting task. And once it’s done, that’s it.
There are various costs involved in setting up a new business, but these costs are not as expensive as they used to be. People often hesitate to start a business because of the perceived high cost, but it doesn’t have to be super expensive. That is past tense.
3 reasons to include:
1. Separate legal entity = greatly reduced personal risk
It is important to separate the business owner from the business to minimize their risk. Once incorporated, the business is a separate legal entity for the owner, unlike when the business falls into the category of sole proprietorship.
As mentioned earlier, there are still director or fiduciary duties such as tax, GST and PAYG. However, if the company is ‘disbanded’, the entrepreneur’s personal assets are less at risk. This cannot be said in the case of a sole proprietorship where, if sued, the entrepreneur’s personal assets could come under attack – even force bankruptcy.
2. Availability of credit
Another reason to include is because banks prefer lending to businesses. Many sole traders cannot secure even a small raise on their credit cards. That seems to change once they take out and apply for a business credit card, where the bank will happily provide them with a $20,000 credit card.
For some reason, the bank thinks that once you’ve set up, you’re a serious business. It’s bizarre, but that’s the way it is in Australia. Getting bank loans for the business also seems to be easier if you are a business.
You will be seen as more serious and likely to bring in bigger clients.
In addition, once you incorporate other companies, your company will start taking your business more seriously. Right or wrong is the perception that you are more established and involved in the company than if you were still a sole proprietor. Some companies don’t even do business with a sole proprietorship, they just award the contract to a corporation instead of a sole proprietor.
3. The company is more attractive to potential investors
It is also easier to obtain investments when a company has been set up that is ready to issue shares to the investor.
It can be easier to sell a business, especially if the new owner doesn’t want to transfer the costs of transferring contracts, insurance, trademarks, subscriptions, and the like to a business. That is, they can just buy the stock in the company.
Transfer your business
As you can see, there are many legal and non-legal benefits to moving from a sole proprietorship (or even a partnership) to a separate legal entity. Once you consider the legal, financial and other benefits, it really is a “no brainer”.
If you know you’re going to be recording it in the near future, why not do it now? Protect your business and take advantage of all the benefits that integration can bring.
Ian Aldridge is the founder and principal attorney at law at Progressive Legal. He has over 15 years of experience advising companies in Australia and the UK. After working in commercial litigation for major Australian and international law firms, he decided to establish a “NewLaw” law firm in Australia and assist growing Australian companies by doing law differently. He holds a double degree in Law (Hons) and Economics (with a major in Marketing). He was admitted to the NSW Supreme Court in 2005.