Structuring a new business - How to?

Structuring a new business.

Hi all, just wondering if anyone on here is savvy when it comes to small business structures?

When the time comes, I'll be happy to sit down formally (i.e. commercially) with someone to set it all up correctly and will need an accountant too, (any recommendations?) but its early days at the moment so just trying to educate myself a little

Without giving too much away, (in case anyone at work sees this), I am a consultant of sorts. My current employer is awarded a contract to produce a set of documents, once the contract is awarded I produce the documents based on information provided from third party consultants and deliver a package to our client for the agreed project price.

My friend and colleague is the same, and together we are currently number 1 & 2 in our organization, delegating work to other employees and project managing each job.

Our 'boss' doesn't do a great deal, contracts are awarded to us based on the quality of work myself and colleague have consistently produced over the years. I deal direct with my clients. In my industry, clients follow individual employees rather than sticking loyally to a particular company. My employer essentially just does the invoicing and pays the office bills. I tender the projects and run them from start to finish.

My "boss" is looking to retire soon and often talks about when the time comes myself and colleague buying the business from him. This is where it gets interesting, as there is no way either of us would be interested as we'd essentially be buying ourselves if that makes sense? The rest of our staff are 'workers' as such, in in some cases are more of a liability to the company than a bonus. The company has very little in the way of assets. We have both said for a few years now that once he decides to sell we'd be going out on our own as sole traders, we would not buy it and there is no market for others to buy it.

The industry is one where you do not need a lot of staff to be profitable, there is plenty of work for a two-person operation, that without the overheads of a medium sized company, would be in a great position.

I've seen a LOT of small companies in my line of work start up, do well, get greedy, expand way too quickly then drop the ball on a big project and end up in administration, (as has happened to my current boss 3 times now).

I am interested in starting something up with the intention of remaining small. As I say, there is a limited marked to build a large company up with the intention of selling a marketable business further down the road but what I am interested in is starting up in a structure that allows us to work in the industry I am familiar with, without the overheads and "deadwood" of a larger operation. I don't mind working hard for a living, I'd just like to see a bit more of what it is I'm working for if you know what I mean?

Assets and outlay:-

As far as initial outlay goes, we would need to purchase computer equipment and two software licenses, (the software license being the most expensive part). These licenses are generally not transferable once purchased unless they are sold as part of a company sale.

Liabilities:-

As far as liabilities are concerned, project values are in the region of $15-$20k per project, which would entail in the region of 100-150 hours say. If a project is WAY under quoted and the hours blow out, then the liability personally is having to work for free to complete the project.

The big liability issue is that the documentation provided is used to produce something, if that documentation is incorrect and proven to be the fault of the new company then the resulting costs could be in the hundreds of thousands. This is the biggest concern for me, in how do we limit that kind of liability?

My current company contacts have a clause which states that any back-charging from clients is limited to a maximum of 10% of the value of the contract to us, but I am not sure how that would stand up in court and would not like to test it.

Structure:-

We would have several projects running at the same time, some will make a profit, some may make a "loss" (in terms of not making as much profit as we'd like) In real terms, there's little scope to make an actual loss as we are producing something from nothing if that makes sense? Our overheads are tiny. We both do the exact same kind of work but may do different hours each week, so another concern in structuring is the fairest way of distributing the profit and the liabilities of the losses. I should point out that, unless we get sued for something, see above, the 'losses' incurred would be in the way of running out of hours on a project so having to work for free to complete it.

I've read around a little on the various forms of structure, Sole Trader, Trust, Partnership and Company and looks like the best way to limit liability issues is to form a Company?

The way a lot of small companies in my industry work is they have two companies. One company purchases all the equipment and the other is the trading company, winning the projects and employing the staff, that way if the trading company fails the assets are somewhat safe in a separate company.

My current thoughts are:-

1 - As we both do the same thing and will need to put in the same start up costs, my thinking is we purchase the software and equipment personally, one set each. That way if we part ways the asset distribution is easy and is not owned by the company? In doing this though, is there a mechanism to be able to claim or depreciate those equipment costs if they are not bought through a company?

2 - We then set up a company where we are 50/50 equal shareholders. This company wins the contracts and rents the office, pays the bills and reports it's profits and losses etc. and limits our personal liability.

3 - We agree on an hourly rate that the company will pay us by periodically drawing down profit (effectively a wage), that way, if we work more or less hours than each other the money taken out of the company in the form of wages is pro-ratered to the work put in. I assume this drawn down would be listed on our individual tax returns? Can you simply draw down profit as you go, or do you actually have to pay yourself a wage? I'm not sure of the tax implications to the company on this one?

4 - Periodically, (annually maybe)? Profits are distributed from the company after company tax is paid, to each of us pro-ratered based on the number of hours worked that year. An agreed amount is left in the company as 'float' to cover 'wages' on future projects that overrun, or have late paid invoices etc. Again, that draw down would be declared on our personal returns.

Does that sounds feasible? Can we purchase the software and hardware personally yet still deduct it on our personal returns?

I think a Partnership maybe easier in terms of filing taxes and reporting etc, and may work in much the same way but I don't think the liability protection would be as good as a company?

Would love to hear some thoughts and suggestions and sorry for the huge post.

Cheers.
 
The liability issue you are talking about would be covered by your professional indemnity insurance.

As for the rest of the structuring stuff, most businesses use a company of some description. Since you are going to be in business with another partner, then a company structure or a unit trust since you want a pre-defined allocation of the profits.
 
The liability issue you are talking about would be covered by your professional indemnity insurance.

As for the rest of the structuring stuff, most businesses use a company of some description. Since you are going to be in business with another partner, then a company structure or a unit trust since you want a pre-defined allocation of the profits.

Thanks Aaron, forgot all about indemnity insurance.
 
1 - As we both do the same thing and will need to put in the same start up costs, my thinking is we purchase the software and equipment personally, one set each. That way if we part ways the asset distribution is easy and is not owned by the company? In doing this though, is there a mechanism to be able to claim or depreciate those equipment costs if they are not bought through a company?

you need to consider personabl bankruptcy as well. Weigh up using a separate trust to own assets and have these leased to the trading company.

2 - We then set up a company where we are 50/50 equal shareholders. This company wins the contracts and rents the office, pays the bills and reports it's profits and losses etc. and limits our personal liability.


Yes.

3 - We agree on an hourly rate that the company will pay us by periodically drawing down profit (effectively a wage), that way, if we work more or less hours than each other the money taken out of the company in the form of wages is pro-ratered to the work put in. I assume this drawn down would be listed on our individual tax returns? Can you simply draw down profit as you go, or do you actually have to pay yourself a wage? I'm not sure of the tax implications to the company on this one?


You can pay yourselves a wage and/or director fees and/or dividends to the shareholders. Employees probably should be on wages.

Any income you receive will be income for tax purposes.
Company may be able to claim wages as a deduction.

4 - Periodically, (annually maybe)? Profits are distributed from the company after company tax is paid, to each of us pro-ratered based on the number of hours worked that year. An agreed amount is left in the company as 'float' to cover 'wages' on future projects that overrun, or have late paid invoices etc. Again, that draw down would be declared on our personal returns.


Profits are usually paid to shareholders in the form of divdends. You might want to introduce a bonus scheme to take into account hours worked.

Does that sounds feasible? Can we purchase the software and hardware personally yet still deduct it on our personal returns?


Personally claimable? maybe - but how does it derive income for you?

Does the licence allow you to own it and use it for a third party?

I think a Partnership maybe easier in terms of filing taxes and reporting etc, and may work in much the same way but I don't think the liability protection would be as good as a company?

Personal partnership is very dangerous as both partners are joint and severally liable. Your partner could enter a contract without your knowledge and your personal assets would be exposed.
 
Thanks Terry.

Re. Trust for purchase of assets, is it possible to claim the costs of those assets as a tax deduction when in a trust that's separate from the trading company?

Yes, the software can be used for a third party, but used by us for that third party. In essence, the third party will always be the trading company though. Not sure if that would make it deductible on the personal returns? Could we operate as a sole traders, purchase the software as two seperate sole traders then contract ourselves to our own trading company?

Dividends from the company, can you pay dividends up to the point that makes the company profitless? (neutral) Essentially the company has no tax to pay then, and all income that we take from it as dividends is then taxed on our personal returns?

Cheers.
 
Re. Trust for purchase of assets, is it possible to claim the costs of those assets as a tax deduction when in a trust that's separate from the trading company?

The trust can claim the cost/depreciation against income it receives.

Could we operate as a sole traders, purchase the software as two seperate sole traders then contract ourselves to our own trading company?

Could

Dividends from the company, can you pay dividends up to the point that makes the company profitless? (neutral) Essentially the company has no tax to pay then, and all income that we take from it as dividends is then taxed on our personal returns?


Dvidends can be paid as discretion of directors subject to the consitution of the company
 
Firstly good on you for starting your own business! Just my thoughts (started up 5 years ago).

Possible to start up while still working for your current boss? Everyone and everything gets paid before you do when you have your own business - so its good to fall back on some definite income in the early days.
I believe in a partnership you are liable for your partners debts if they cant pay.

In my type of business, all expenses (equipment/staff/phones/etc) are paid for by the business trust, all expenses/depreciation are claimed as deductions through trustee tax return at EOFY -whatever remains is actual profit. Each month I pay all the bills and then "pay" myself any profit left over. This is tricky in the first year because you are getting a feel for cash flow so you may not want to draw any wages. At EOFY I "receive" 100% of the profit which I claim as my business income on my tax return.

If you each take on your own projects then just take profits for your own project. If you do a joint project then pay each other a percentage. Cheers nat.
 
Thanks Nat. Makes sense.

No way we could start up and keep working for current employer as most of our current employers clients would follow us! The projects are always fast tracked and full on, it'll be full on from day one once we start up.

Cheers.
 
Thanks Terry. Seems the sole trader plus trading company may be the easiest way to go.

Cheers.

Generally you would have your own company as a shareholder/unitholder in the main operating company as having a personal owner has tax implications which you may not like.
 
Thanks Aaron.

Sounds like it starts to get complicated then? As in, I'd have my own company that owns my software, then I'd be a 50% owner director of the trading company, of which my own company is also a shareholder?

Does my company need to be a shareholder at all? Can my company that owns the software, and my friends company that owns his software just lease the software to the trading company for a marginal sum (enough to be able to start deducting the software costs from the lease income over time).

Actual income then bring drawn as directors fees from the trading company and declared on our individual tax returns?
 
Sounds like it starts to get complicated then?

Its complicated ...In my case once I got started, I spoke to an accountant (who then engaged a lawyer) to set up the business structure/trust/register with ASIC etc. My business is now X Holdings PTY LTD as Trustee for XY Family Trust trading as XYZ ... When you are ready, see an accountant because things may be more complicated with a partner ie what happens if you/he wants to sell 50% share in the company, take on new partner, expand business, sell off assets etc. also if turnover in excess of $75K PA need to register for GST. Workcover, business loans, prof liability, lease contracts, bus insurance, office setup... Theres a fair bit to do.

Sounds like you will be full steam ahead day 1. Cheers, nat
 
Generally not a good idea to run a business in a trust I think. The main reason is, with a discretionary trust at least, you cannot easily transfer party of the business or bring in 'partners'. Better to have a company with the shares owned by a discretionary trust I think.

On the other hand having a trust allows you to more easily stream income out before paying dividends.
 
Thanks guys, at least for the moment I now know there are mechanisms for achieving what we want to do.

Next step is to formulate a business plan, get all the costings together for outlay and amass some cash buffer. Time frame at the moment will be around 12 months from now.

I'll be looking for an accountant & lawyer in about 6 months time I should think, see how we're tracking by then and then start getting the structures in place.

Cheers.
 
I think we all agree that it is complicated ... even for a simple business.

I just wanted to agree with you regarding not "buying" the bosses business. Asides from physical assets, all a company really owns is goodwill - and nowadays, with the ability to set up and run very similar businesses - there is very little goodwill.

In fact - I'd say goodwill no longer exists in business. Customers don't have loyalties like they used to 20+ years ago and are now product , quality and price driven instead.

Enjoy the journey. I knew some who did something similar for medical equipment, and was doing rather well internationally. Good luck
 
I think we all agree that it is complicated ... even for a simple business.

I just wanted to agree with you regarding not "buying" the bosses business. Asides from physical assets, all a company really owns is goodwill - and nowadays, with the ability to set up and run very similar businesses - there is very little goodwill.

In fact - I'd say goodwill no longer exists in business. Customers don't have loyalties like they used to 20+ years ago and are now product , quality and price driven instead.

Enjoy the journey. I knew some who did something similar for medical equipment, and was doing rather well internationally. Good luck

I have to disagree with this, a good company with strong track record, good systems, exclusive agreements etc can be worth a hell of a lot more than just it's physical assets, finding/growing such businesses is a big part of what I do for a living. As an example, an industry I've become involved in this year has seen valuations rise from 2.5-3 times multiples to 3-4, all in the last 12 months in perth

Re the OP, the structure options may sound complicated but they really aren't once you get your head around them. Personally I'd suggest sitting down with Terry or someone of his competence and paying for an hour or so of their time.get some qualified, specific advice and, most importantly, understanding. You can then use the next 6 or so months to make an informed decision as the clarity will help.

I see this sort of thing a lot, businesses where the founders were so keen to just get on with it that they didn't structure things properly at the start and it can become a nuisance later on.
 
Thanks Sanj, I will absolutely be sitting down with Terry or the like to get things fine tuned before we go too far.

I agree with both you and Lizzie, but it is very business/industry dependent.

My line of work relies on the people doing the actual job. There is little in the way of assets and our clients come to us specifically because of what myself and my colleague do for them. As I said in my, (rather long), original post, to buy the company from our boss would essentially mean we are buying ourselves. It makes no sense.

Cheers.
 
Absolutely, it's certainly industry dependant and I agree in your case it sounds like setting up your own business makes sense.

Best of luck with it, owning your own business can be incredibly rewarding so I hope your venture goes well.
 
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