Companies: what they are and how they work

Companies: what they are and how they work

When talking about business structuring, most people naturally think that involves starting a company – and for the most part, they’d be right. However, whilst most people know about companies, I regularly come across clients who may not know exactly how they work and what the various terms connected with companies actually mean. Hopefully this basic summary sheds some light.

The Basics

A company is a separate legal entity. This means that, legally speaking, it has (most of) the rights and obligations of an individual, and exercises its decisions as if it was its own individual. This means that it can own assets, incur liabilities, sue and be sued, transact and carry on a business in its own right. Importantly, those assets and liabilities that a company may hold are not your assets and liabilities even if you own the company. This is a fundamental aspect operating a business under a company structure – the ability to isolate the risk of operating a business in a separate entity, thereby not exposes yourself to the risks of operating that business.

Key points

Companies are comprised of:

  • Shareholders, who own the company. The number of shares held by a shareholder determines their proportionate ownership in the company. This in turn governs the percentage of profits that that shareholder is entitled to receive (called dividends), and the voting rights that a shareholder may have in connection with the governance of the company; and
  • Directors, who run the company. The directors are voted into the role by the shareholders, and once appointed, become responsible for the operation of the company. In a small business setting, it is common for the shareholders and directors to be one and the same. However, as a business grows it is common for third parties to be appointed to the board to help in the management and operation of the company.
Companies: what they are and how they work
In the above example, Jane and Jim are the directors of Startup Co Pty Ltd. Startup Co is a company with two shareholders, which are owned by Jane and Jim’s family trusts. 

Positives

Flexible

A full rundown of each and every type of company and how they work is beyond the scope of this post. For the moment it suffices to say that companies are a flexible means of business ownership, which can be scaled for a range of businesses. They range in size from a single shareholder and sole director organisation to publicly listed multinational operations, such as BHP, Apple or google. This flexibility makes them an ideal business structure for most startups. Further, companies which operate a business and turnover below $50m are taxed at a flat rate of 27.5% (with plans to reduce that to 25% over the coming years), which is substantially lower than the mid-high tax rates applicable to individuals. Even the ordinary company tax rate of 30% is substantially lower than most individual tax rates. 

Investor ready

If you plan to take on investor capital in order to grow your business, particularly venture capital funding, then those investors will most likely require that your business operate under a company structure. Therefore, a company run business (as opposed to a partnership or a trust) is ‘investor ready’ from the start, without requiring costly restructures. 

Multiple owners

A company is an ideal way in which multiple people who are unrelated to each other can co-own a business. This is because of the way ownership is split into shares, which can be held by seperate individuals. This allows investors to pool their funds to build and grow a business, whilst also spreading the risk of that venture between them. Where multiple people own shares in a company, its strongly recommended that a Shareholders’ Agreement be put in place to regulate the relationship between them (what goes into a shareholders’ agreement will be covered in its own post shortly).

Drawbacks

There aren’t many drawbacks to operating your business as a company – it is just that in some cases a trust or partnership could give you a better tax outcome and would therefore be recommended. This emphasises the point when it comes to business structuring, there is no one size fits all: your business structure is tailored to suit you and your business.

There are a couple of things to be aware of:

  • certain capital gains tax concessions are not available to companies but will apply to trusts. Therefore, certain businesses would be better served adopting a trust structure;
  • companies can be difficult to administer, and will usually require that your accountant play a more hands on role in the administration of your business. This includes ensuring renewal fees get paid and annual reports get lodged with ASIC (the organisation responsible for administering companies), not to mention compliance with Corporations laws, which are some of the most complex laws in Australia; and
  • a company will require its own tax return to be lodged, increasing your annual accounting costs for each year.