How to choose the right business structure for a growing company
Sponsored content. This article was supplied by a third party and Business Money has been paid to publish it.
Photo by Yan Krukau
Choosing a business structure can feel like an administrative task that simply needs to be completed before trading begins. In reality, it is one of the more important decisions a founder makes.
The structure you choose can influence who owns the business, how decisions are made, personal liability, access to investment and the administrative responsibilities that follow. A structure that works perfectly for a small one-person business may become restrictive when the company begins hiring employees, introducing new shareholders or expanding into other markets.
There is no single structure that suits every business. The right choice depends on where the business is today and where its founders expect it to go.
Understand the main business structures
The exact terminology varies between countries, but most businesses operate using one of several common structures.
A sole trader or sole proprietor operates a business personally. This is often one of the simplest ways to start trading because there is relatively little separation between the owner and the business.
A partnership allows two or more people to operate a business together. Partnerships can be useful where founders want a relatively straightforward arrangement, although responsibilities, ownership and profit sharing should be clearly agreed.
A limited company is generally established as a separate legal entity from its owners. Ownership is typically represented through shares, with directors responsible for managing the company.
Other structures may also be available for charities, professional practices, investment businesses, joint ventures and organisations established for a particular purpose.
Before completing any company setup, founders should understand the differences between the structures available and consider how each one fits their long-term plans.
Think beyond the first year
One of the most common mistakes when choosing a structure is looking only at what is easiest today.
A freelancer starting a small consultancy, for example, may require a very different structure from a technology startup planning to raise external investment within 18 months.
Ask where the business could realistically be in three to five years.
Will there be several owners? Will investors be introduced? Could the business employ 20 people rather than two? Is international expansion likely? Could the founders eventually sell the business?
Thinking through these scenarios helps avoid choosing a structure purely because it appears to involve the least administration at the beginning.
Consider ownership carefully
Ownership becomes increasingly important as a business grows.
Where several founders are involved, they should agree who owns what percentage of the business before problems arise. A simple 50/50 split may sound fair, but it can also make decision-making difficult if the founders disagree.
Businesses expecting future investment should also consider how new shareholders could be introduced and how ownership might become diluted.
This is particularly important for startups. Investors generally want a clear understanding of who owns the company, what rights different shareholders hold and whether there are any unresolved agreements between founders.
A clear ownership structure from the beginning can make future investment discussions considerably easier.
Understand personal liability
Liability should also influence the decision.
Some business structures provide little or no legal separation between the business and its owner. Others establish the company as a separate legal entity.
For a very small, low-risk operation, founders may initially be comfortable operating personally. However, the risk profile can change as a business grows.
Hiring employees, signing leases, purchasing equipment, borrowing money or entering larger customer contracts can all increase the financial obligations of a business.
Founders should understand exactly what liabilities they could personally face under their chosen structure and seek professional legal or financial advice where necessary.
Consider how you plan to raise money
Funding requirements can quickly expose weaknesses in an unsuitable structure.
A founder funding a business entirely from personal savings may have considerable flexibility. A startup hoping to raise money from angel investors or venture capital firms generally requires a more formal ownership structure.
Potential investors need a mechanism through which they can invest and receive an ownership interest. They will also expect appropriate governance, financial records and documentation.
Even if external funding is several years away, choosing a structure that can accommodate investment later may reduce unnecessary restructuring.
Don’t choose a structure based on tax alone
Tax is naturally an important consideration, but it should not be the only one.
Different structures can result in different tax obligations for both the business and its owners. However, the lowest headline tax rate does not automatically make a structure the best choice.
Administrative costs, accounting requirements, how profits are extracted, future investment plans and personal circumstances can all influence the final outcome.
Tax rules also change over time and differ considerably between jurisdictions.
For that reason, founders should discuss their circumstances with an accountant or tax adviser rather than choosing their company structure based on a tax percentage found online.
Think about administration and compliance
A more formal business structure usually brings more formal responsibilities.
These might include maintaining corporate records, submitting annual filings, preparing accounts, recording changes to directors or shareholders and keeping company information up to date.
This should not necessarily discourage founders from incorporating. Instead, the administrative requirements should be understood and planned for.
As businesses grow, clear company records can become an advantage. They provide a documented history of ownership and management decisions and can make due diligence easier when dealing with investors, lenders or potential buyers.
Consider international expansion early
Digital businesses can reach international customers almost immediately, but selling internationally is very different from establishing a business presence in another country.
A company may eventually decide to establish a local entity because it is hiring employees, opening an office, working with major customers or entering a strategically important market.
Before incorporating abroad, founders need to understand the company law, tax, director, address and compliance requirements of the jurisdiction they are entering.
For example, entrepreneurs considering setting up a company in Ireland as a non-resident should review the formation requirements before deciding how an Irish entity will fit within their wider business structure.
The same principle applies to any overseas expansion: establish the commercial reason first and then determine the most suitable legal structure.
Review the structure as the business changes
Choosing a company structure is important, but the first decision does not necessarily have to remain unchanged forever.
A business can evolve significantly.
A sole trader may develop into a company. A business owned by one founder may introduce new shareholders. A domestic company may establish overseas subsidiaries. A small owner-managed business may eventually prepare for acquisition.
Major changes in revenue, ownership, funding or geography should therefore trigger a review of the existing structure.
Build for the business you want to become
The best company structure should support both the current business and its realistic future direction.
Founders should consider ownership, liability, investment, administration, taxation and international expansion together rather than treating them as separate decisions.
Getting those foundations right does not guarantee business growth. However, it can remove unnecessary barriers when opportunities arise.
A company that has been structured carefully from the outset is generally in a better position to introduce investors, expand into new markets and adapt as the ambitions of its founders grow.