So your business has started to take off — well done. You’ve sold your product or service and you’re making money. You feel like you have done the hard yards as a sole trader, and you think you could be ready for the next step: incorporating a company.
But what would your business look like? What are the pros and cons? And how do you know you are ready?
You might be thinking, well, it’s only me and my partner or friend, but the time has come to employ someone to help us. Or maybe someone realises this business you started is not bad and they want to invest. Do you give them shares? How does all this work?
Have these thoughts popped into your head when thinking about starting a company?
- “Yuk! Scary! Accounting and tax paper work!”
- “I don’t want the hassle.”
- “It sounds expensive.”
- “Why do I want to set up a company? I am happy — I am charging my clients, they are paying me, and I should be fine.”
If you are already feeling overwhelmed, don’t, because the process is as simple as trading in your bike for a car.
Consider this as an opportunity for your business to grow, so consider two things:
1. How much money are you making?
In my opinion, to justify the expense in setting up a company or incorporating, you need to be making (gross business revenue, not profit) $75,000, which means you get the entity registered for GST and an ABN.
2. If something goes wrong in your current structure, are your assets protected?
Put simply, conducting a business through a company can shield you and your personal assets from the debts of the company as your personal liability. The larger the business grows, the larger risk to personal assets, and the more they need to be protected.
What does it mean, legally?
From a legal point of view, the company is not you. You can be a shareholder and director, but the company is not you. It acts in its own name, and — just like you — can earn income, pay expenses and be sued.
What about tax implications?
A company pays tax at the corporate rate, which is currently 30%. However, there has been speculations that this could drop. Sole traders pay tax depending on their personal marginal rate. This is because income earned through a business operated by a sole trader is assessable income in the hands of the sole trader.
Are there any fees?
There are a number of costs associated with incorporating a company, including an ASIC registration fee of $444 and an ASIC annual review fee of $231 per year. You would then have accounting and advice cost on top of that.
So how do I incorporate my business?
You may have registered your business name and trading name (abr.gov.au). However, this is not a legal entity. You need to register that and the company name with ASIC. If you want your company to trade under a different name, you’re also required to register the trading name as a business name.
2. Decide on shares
Setting up a company can be done online or with an accountant. You’d usually have a Pty Ltd, or ‘proprietary limited’ at the end of the name. This means the company cannot have more than 50 shareholders and is restricted in the number of overall shares: hence the name.
It does mean that you issue stock — the unit of ownership in the company. The easiest way is to declare you have 1000 shares of stock for $1, and divide it between the founders or parties investing. The shareholders’ names and units are put on the application, the funds go into the bank account and off we go!
If you are a shareholder, you need to decide if shares are to be in your name or in a trust’s name. Setting up a trust can create more costs, but it is worth discussing with your accountant or adviser.
3. Establish directors
Next you have to establish the directors, who by name are responsible for the corporate actions of the company and are generally the key decision makers in running the business. Asset protection for the directors is where incorporating has an advantage over operating as a sole trader, as directors are part of a Ltd (Limited Company), which means the assets at risk are limited to company assets.
This differs heavily from a sole trader, which is not limited. If a sole trader cannot repay or satisfy a debt, then creditors can sue the sole trader to recover it. If successful, the creditors potentially have access to the sole trader’s assets, which could include the family home! As you can imagine, the risk of personal bankruptcy is much higher for a sole trader.
What is the big disadvantage of incorporating?
The disadvantage to incorporating is the increased paperwork and cost. Right now we have a government proposing to ‘cut red tape’, but at present, small incorporated businesses have to do BAS, PAYG statements (if they have employees), pay superannuation, track leave, have clear job descriptions, allow sick leave and file tax returns.
A final word
Incorporating does mean more administration, more expense and more attention to detail. But it could also mean asset protection. If the entity is based in Australia, it will also mean a tax rate of 30 cents on the dollar of taxable income, more shareholders, rewarding staff and creating a business that, if sold, may allow shareholders to enjoy tax concessions.