Before raising capital, hiring employees or selling to customers, your startup will need to decide and develop a formal business structure. The type of business structure you have (or decide on) will impact your funding opportunities, tax responsibilities and personal liability.
Sole Trader or Partnership
If you have not actually created a company then, your entity may just be a sole trader. This may not be a big deal when starting out with an idea and some UX sketches. But you will need to quickly move on from there. Sole traders and partnerships make the individual(s) entirely responsible for the business’s liability. They don’t offer any real protection in the event action is taking against your startup: the action will be brought against you personally. Another way to understand this is that essentially, your startup does not exist as an independent entity and your personal and business assets are one.
Company
Registering your startup as a company is often a better option. A company is a separate legal entity operated by directors and owned by shareholders. This means that the company owns the business’ money, incurs the losses and can be sued.
Structuring your startup as a company will provide instant credibility for your business, personal asset protection, and tax flexibility. It will limit liability as in the event that a person sues your business, it will be brought against the company not yourself.
A company has increased funding options to raise capital as a result of the share structure.
The Dual Company Structure
A dual company structure involves having a holding and an operating company.
The holding company owns 100% of the shares in the subsidiary operating company which generally includes the startup’s intellectual property as well as raised capital. The holding company will protect your startup’s major assets from any liability that the operating company incurs. Setting up a holding company requires incorporating an additional company which may make it a structure that is costlier to implement and maintain. The holding company’s main function is to hold the company’s major assets and capital, it does not oversee the day-to-day operating of the business.
Carrying out the operations and day-to-day workings of the business is the operating company’s role. The operating company is exactly what the title implies; it operates the business. It is the entity that enters into contractual agreements with clients, suppliers and employees.
Dual company structures may be costlier to implement and maintain because having two companies entails more complexities, requiring more administrative work and paperwork to be fulfilled. However, the central purpose to a dual company structure is that it provides an extra layer that acts as security protecting your startup’s most valuable assets from the liability that the operating company incurs.
Limiting liability because if a customer or employee were to sue your startup, they will have to sue the operating company as that is the entity they have the legal relationship with. This keeps your startup’s major assets out of the equation and away from risk as they are owned by the holding company. For these reasons, startups that own valuable intellectual property favour the dual company structure.
Even in the unfortunate event of an operating company’s insolvency, the assets held with the holding company would be protected from creditors and other liabilities. The structure’s ability to minimise risk by providing security of assets allows a startup to be more daring in diversifying and exploring new ventures at ease.
Trusts
Alternatively, a trust arrangement may be a more favourable structure for your startup. Firstly, a trust is a legal instrument operated by a trustee for the benefit of its beneficiaries.
There are three different trust structures a startup may adopt; a discretionary trust, unit trust or hybrid trust. A discretionary trust is the most advantageous trust structure for a founder to use in order to own their shares in their startup without owning them personally. When a discretionary trust is gifted to a corporate trustee, that trustee, which is the director of your startup, becomes in control of the trust. The trust deed will specify certain classes of beneficiaries that are entitled to receive the proceeds of the trust. Then you as the trustee have the absolute discretion to distribute those proceeds among the beneficiaries as you deem fit.
Appointing a corporate trustee when setting up a discretionary trust allows for additional protection such as limited liability. If a trust has a corporate trustee, the company’s shareholders receive protection through the company’s limited liability. However, appointing a corporate trustee requires you to incorporate another company and increases your setup and maintenance costs.
Under this type of arrangement, a specific beneficiary does not have a right to the trust money unless and until the trustee decides to distribute funds to that beneficiary. Thus, the director as a trustee is not required to distribute to any of the beneficiaries if they do not wish to do so.
This structure offers asset protection from creditors because the assets of a discretionary trust are distinct from the assets of the beneficiaries of the trust.
The discretion granted to the trustee in distributing income makes it a flexible structure for tax planning as the trustee can distribute to beneficiaries with lower marginal tax rates. Generally, trusts that have held their shares for longer than 12 months could be eligible for a discount on capital gains tax when they sell their shares.
Registering your company in the US
If your company intends on operating in the US, or servicing customers and clients in the US, then setting up a company in the USA makes sense. Americans, be they incubators, venture capitalists, equity sources, suppliers etc. will always prefer to deal with a company that is registered in the US rather than offshore. Usually that will mean setting up a company in the State of Delaware, as it is the state with the best defined corporate governance law and court system in the States.
Making the right choice
There is no one right choice as structuring your startup right requires an assessment of yours and your business’ needs. But whichever way you decide to structure your startup, the goal should be to minimise risk and cost while maximising flexibility.
Speak with our startup team if you need some insights into how to best structure your startup.
Phil is a director at OpenLegal. He has over 16 years experience working in private practice and in-house counsel in Sydney and London, giving him expertise in employment law, IP, finance, leases, dispute resolution, insurance and contracts.
Raymond is a legal intern at OpenLegal, working with our legal content team. He is currently a penultimate student at the University of Technology Sydney, studying a Juris Doctor degree with an undergraduate Bachelor of Global Studies. He is particularly interested in Intellectual Property law and the increasing internationalisation of that area of business.
