Setting the right business structures is one of the most important decisions you will make for your business.
As commercial advisors, we often get asked what the difference between a trust and a company is. While a trust and a company have some similarities, they are ultimately different types of business structures with different purposes.
What are the types of business structures?
At its core, a business is any activity engaged in to make a profit. There are many ways to own and operate a business, such as:
1. Sole trader
- Business is conducted in the name of the individual
- No separate legal entity
- Two or more people go into business together
- No separate legal entity
- A separate legal entity able to do business in its own right
- A legally recognised relationship where one person holds the business assets for the benefit of another
|Handpicked related article: Corporate Structuring: Are You Parking Your Bright Idea in the Right Spot?|
Let’s delve deeper into the difference between a company and a trust:
What is a company?
A company is a separate legal entity that can hold assets in its own name. As a result, its shareholders do not own the company's assets, nor are they liable for its debts. The most that a creditor of the company can recover is usually ‘capped’ at the maximum unpaid equity of the company (or in some cases, the maximum amount for which the company is insured).
A company is especially useful during the ‘start-up’ phase of a business as there is no obligation to distribute profits to shareholders at a particular time (as would be the case with a unit trust). The profits of the company from the first year of its operations may be reinvested into the company to grow the business.
Many start-ups also use a company as a means to manage risk and protect directors and shareholders from certain adverse consequences.
A company is attractive for external investors because it is regulated by the Corporations Act 2001 (Cth) (Corporations Act). Under the Corporations Act, the directors of a company can be held personally liable in some cases, including where they breach their duties to act in the best interests of the company.
What is a trust?
A trust is a relationship where one person, known as a trustee, holds the ‘legal’ title to certain assets on ‘trust’ for other persons, who hold the ‘beneficial’ title to those same assets. It is these beneficial owners who will ultimately be entitled to the assets and any income derived from the use of those assets. The trustee does not have any right to benefit from those assets (other than through a fee for services as a trustee).
There are several different types of trusts, but the two most common ones in business structures are discretionary trusts, which include family trusts, and unit trusts.
As suggested by its name, the trustee of a discretionary trust has the discretion to determine how much is paid to each beneficiary under the trust. The beneficiaries of a discretionary trust do not have a fixed entitlement.
The many benefits to operating your business through a discretionary trust include:
- ease of succession;
- carrying forward of losses; and
- tax optimisation and capital gains tax discounts.
Unlike a discretionary trust, the interests of each beneficiary of a unit trust is proportional to the number of units they hold in the unit trust. Sounds familiar? That’s because it is similar to a company, where the entitlement of each shareholder is proportional to the number of shares they hold in the company.
The benefits of a unit trust include:
- less regulation than a company;
- tax optimisation and capital gains tax discounts; and
- relatively easy to wind up.
There may be a myriad of benefits in a trust structure. However, trading trusts are a complex and expensive business structure.
|Handpicked related article: A Short Legal Checklist for Innovating Startups|
Why is this important?
The business structure you choose will have different consequences in terms of ownership, control, ongoing costs, personal exposure to liabilities, and sale of the business. Due to the complexities and cost to unwind and restructure a business down the road, it is crucial that you set it up right the first time around.
At the end of the day, the business structure you choose should:
- be flexible to accommodate changing circumstances while minimising negative consequences;
- provide adequate asset protection;
- allow for business profits to be distributed efficiently; and
- minimise costs, and optimise tax liabilities.
Does your business need help with setting up the most appropriate business structure? Speak to one of our business structuring experts today.