Outline of PPT - Activity 3 (SS)
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Deakin University *
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LML 6006-1
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Law
Date
Feb 20, 2024
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Activity 3.1 DRAFT Presentation Outline
Instructions
: Outline the appropriate business structures for the client’s proposed enterprise. The presentation should outline:
●
the most appropriate business structure(s) that should be recommended to the clients to meet the clients' objectives
●
any revenue and duty implications which influence your recommendations
●
is there any other advice the clients should be obtaining, and
●
if finance is required to fund the clients' commercial enterprise:
o
what alternative form(s) of financial or security arrangements are available (including equity finance), and
o
what obligations and liabilities will arise for the clients under these arrangements.
Facts:
John Mann
and Lin Chen
propose to purchase the VeryBelle Homes
business from the company vendor (Design and Build Pty Ltd). You were asked in your supervisor’s memo to research possible business structures.
Clients referred by M & M Business Brokers. ●
10 minutes to present. ●
Tailor advice and recommendation to client’s circumstances. ●
10-12 slides
●
Use colour, diagrams and flow charts.
Outline of PPT Slides 1 – 5:
1.
OUTLINE THE BACKGROUND/SUMMARISE FACTS GIVEN. Client’s personal circumstances and objectives/assumptions made:
1.
To purchase, operate and own VeryBelle Homes together, which is a design and construction business. 2.
To combine your talents in business together. 3.
To find investors in the future, to build display homes in another display village, and possibly undertake house and land developments – this will be an important consideration in our advice regarding the appropriate business structure. -
Do they or any family members want to work in the business? Nothing mentioned in facts re this. -
What are the client’s goals in relation to the business going forward? Above at #3. -
Mention the structure we will be recommending: COMPANY. The possible types of business structures for VeryBelle Homes include:
1.
Company;
2.
Partnership; or
3.
Unit/Discretionary Trust.
Please note, sole proprietor is not included as an option here - given there is more than one person
involved in their business. We will be recommending the company structure, this will be explained on the next slide. 2.
RECOMMENDED BUSINESS STRUCTURE: COMPANY A company is a separate legal entity. Companies can hold assets and distribute dividends to
shareholders. Companies are commercially well understood and accepted; it is commonly recommended to conduct a business through a company
We recommend a company structure because: ➔
It will be an
easy transition given “VeryBelle Homes” is currently managed by a company. ➔
The changeover costs will be significantly less
since there will be no alteration to the current structure of the business (for example, duty on the transfer of assets, the possible impact of the Capital Gains Tax (‘CGT’) and the possible loss of income taxation benefits). ➔
As building companies are known to operate on slim margins, and often attain debts exceeding the value of business assets – it is important that your business assets are
protected. ●
A company has its own separate legal entity with perpetual succession and is owned by shareholders and managed by directors. The liability of
shareholders or members is limited
and you will not be personally liable for the debts of the company. ●
Therefore, your family assets will be protected because a company must pay its debts from its own resources. ➔
To fulfil your future goals, there is flexibility to expand the business by issuing additional shares later to attract investors. ➔
The tax rate for a company is significantly less than the highest tax rate for individuals. ➔
Companies are also commercially well understood and accepted. However, there are some disadvantages
of a company structure:
➔
The reporting requirements can be complex. ➔
The incorporation of an enterprise may mean that the principals become employees of the company, giving rise to exposure to payroll tax and compulsory superannuation payments for principals who are employees.
➔
A company is not entitled to claim the Capital Gains Tax discount concession that is available to individuals, trusts and superannuation funds. In a company, payment of dividends is determined according to the number of shares held.
NEW SLIDE: 3.
REVENUE AND DUTY IMPLICATIONS OF COMPANY STRUCTURE
There are many tax advantages of a company structure: ➔
A company is a separate legal entity to the people who manage it. Therefore, the company is a separate taxpayer and required to lodge its own tax return and pays tax on its profits at the company tax rate which is 25% for companies with annual revenue less than $50M and 30% otherwise. ➔
The company can then distribute profits
to shareholders in the form of franked dividends. These dividends are taxable to the shareholders less a credit for the tax already paid by the company. ➔
However, companies cannot access the 50% capital gains tax discount. ➔
Setting up and maintaining is also more expensive than the alternatives, which have greater compliance obligations imposed by regulators such as ASIC. If you adopt a company structure, you will both consent to being appointed as directors. There are a number of
obligations and duties imposed on directors of a company under the Corporations Act 2011
(Cth). In brief, it requires certain formal meetings to take place and requires certain documents to be lodged with ASIC. 4.
FINANCE AND SECURITY ARRANGEMENTS ONLY FOR OUR RECOMMENDED STRUCTURE (COMPANY).
Now we will present several forms of Financial and Security Arrangements available for your
proposed purchase of the business:
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FINANCING
Debt financing = money provided by an external lender.
For a small business such as yours, the most common forms of debt finances are:
-
Overdraft
o
the most common source of short-term finance and are often used to supplement the working capital needs for a business. An overdraft is a loan facility through which the account holder can draw loan funds up to a certain limit. Please note that an overdraft is repayable on demand.
o
Overdraft is repayable on demand. While theoretically the financier can require repayment of the balance owing at any time, a financier must give reasonable notice to a borrower of the cancellation of the facility.
-
Term loan facility: this is a cash advance provided for a specific period and usually also for a specific purpose, subject to the financier’s rights to require early repayment
on default. o
predominantly used to satisfy medium to long-term borrowing requirements, such as the purchase of a major asset. A term loan would be a suitable form of financing as this loan could be specified for the acquisition of VeryBelle Homes. M&M Business brokers have sent us the previous year’s profit and loss statement, and a list of assets – and an important element in a financier’s
decision to provide a commercial loan, is to ensure that the borrower has sufficient cash flow to meet the principal and interest repayment obligations.
o
- which outlines the need to seek further advice from an Accountant.
Other forms may include (
only mention if time permits):
-
Line of credit/credit cards
-
Commercial bills
-
Leasing
-
Bank guarantees
-
Letter of credit
The extent of security required by the bank will be determined by the bank’s credit risk assessment. Equity financing
The above-discussed methods are known as debt financing as they must be repaid. The other means of obtaining finance is through the investment of equity for an ownership share in the entity.
The most common form of this is the provision of funds to a company in return for the issue of shares. Please note however, there is strict control of equity raisings by the ASX under its rules for listed entities and by ASIC under Corporations Act Ch 6D.
Mention if time permits
(re Equity Financing): Public
- If a business meets the requirements of a stock exchange to list, you may choose to
have an Initial Public Offering (IPO) where shares in the venture are offered to the Public for purchase. Furthermore, most equity sales involve the transfer of voting rights within the company. This means that you may be beholden to shareholders opinions, and directions, which could result in you giving up a degree of control in the venture. It is possible to sell shares in the venture with reduced voting rights, however, this usually only occurs in companies that are highly successful prior to their IPO.
Private
- You are able to enter private agreements to sell shares in your business, however you are limited to selling to employees of the firm, and sophisticated investors.
SECURITY
“Security” refers to the rights or interest being granted to the financier over the interest or rights in certain property (usually the property of the borrower) to support a debt or performance of another obligation.
A financier takes security to “secure” the borrower’s obligations to repay the money advanced.
Assets that may be offered as security for business finance transactions:
●
Land or an interest in land
●
Personal property, as defined by Section 10 of the PPS Act as any property excluding land and fixtures attached to land and some statutory licenses, this includes plants, equipment stock in trade, intangibles, intellectual property, choses in action, shares, and life insurance policies.
●
Life insurance policies
As per the assets list we have received from M&M Business Brokers, we would advise that you obtain further advice from the professionals mentioned in the following slides (ADVICE FROM OTHER EXPERTS). Personal property that could be relevant here could be:
●
The intellectual property in the architectural home plans, or ‘registered designs’ ●
Office equipment
Loan and Security documents: It is standard practice in commercial loans, where a company borrower is involved, is to have a personal guarantee and indemnity signed by each of the directors guaranteeing the obligations of the company. Should the business assets be insufficient, the directors of the company shall become liable for paying back the loan.
‘Perfection’
●
The PPS Act has a concept of “perfection” of a security interest after it is validly created and evidenced in writing that describes the collateral and is signed or adopted by the grantor. Commonly perfection refers to the registration of a financing statement for a security interest on the PPS Register
●
We note however, that registration is optional, not mandatory. The benefit of perfection is priority and protection of secured creditor status in the event of the insolvency or bankruptcy of the grantor of the security interest. Alternative Security Arrangements which are not suitable
due to the business assets:
a.
Mortgage over land: A financier can take a legal security or an equitable security over land. b.
A Guarantee:
A guarantee is a contractual promise given by a third party to a creditor, which makes that guarantor jointly and individually liable to repay the debt, in the event of default by the debtor.
5.
OTHER STRUCTURES (NOT RECOMMENDED) PARTNERSHIP
Definition: two or more people or entities who are in business as partners or receive their income jointly. You have asked whether you should purchase the business using a partnership. In general, we do not recommend a partnership structure because it will not meet your objectives. For example, you advised that you wish to find investors in the future and this cannot
occur under a partnership structure.
Other disadvantages: -
the proportion of profits that each partner receives is fixed by the partnership agreement.
-
Each partner has unlimited liability
for debts and the conduct of the business, including for the activities of all other partners in the business which
increases the risk to family assets of both partners. -
The partnership cannot pay wages to an individual being one of the partners - any amount paid to a partner is not therefore a deduction (for tax purposes) in the same way as payments to employees. -
There is no continuity of business
where there is a change in partners and a CGT event may arise. Some advantages:
➔
They are relatively easy and inexpensive to set up considering there are no registration costs (also easy to dissolve).
➔
Partners share equally in decision making, capacity and profits. ➔
Partners can access the 50% CGT discount as they hold an interest in each partnership asset as an individual.
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…
6.
Other structures (not recommended) UNIT OR DISCRETIONARY TRUST
-
Possibly split into two slides?
-
Definitions
-
Advantages/Disadvantages -
Any tax and revenue implications
-
Why we do not recommend this structure. What is a Trust
·
A trust is an obligation that is imposed on a person or entity (trustee) to hold property for the benefit of a group known as the beneficiaries.
·
The trustee is responsible for administering the trust including its tax affairs and other responsibilities.
·
Beneficiaries receive the income from the trust. They are the group for whose benefit the trust has been created for.
Unit Trusts
·
A Unit Trusts operates by a trustee holding the assets of the trust and the income that those assets produce is disbursed to the beneficiaries (also known as unit holders).
·
This form allows for investors such as John and Lin to pool their money and make investments of capital collectively. John and Lin would be able to pool their money to invest in the purchase of VeryBelle Homes.
·
The beneficiaries have an entitlement to the capital investment and subsequently the income that flows from that investment. If you have 25% of the capital invested in the trust, you will receive 25% of the income that is produced from those assets.
Advantages
·
The structure operates similarly to a company where, as the beneficiaries you would hold proportional equity positions in the trust and receive income from the operation of the business.
·
The income from the trust is taxed as personal income. This can be used in certain ways to limit tax liabilities against losses in other parts of your income.
. There is a 50% discount on the taxes owed on Capital Gains from assets owned in the trust. Disadvantages
. The income earned through your business held in the trust must be distributed to you as unit holders. You will be taxed on this income as an individual. If you retain income in the trust it will be taxed at the highest marginal tax rate regardless of your tax position that year.
. You will not be able to claim any business losses as individuals, losses can only be offset against business gains in the future. This can limit your flexibility in your tax position as individuals.
. Your ability to operate the business as normal may be impacted by the decision to operate through a unit trust. Common business activity such as borrowing money from lenders may be complicated by the structure of the business.
Taxation Implications
. The income is distributed to you (Unit holders), and you will pay tax on this money as individuals.
. There is a 50% capital gains tax discount on the gains from assets held in trusts. However it is not possible to defer these taxes through roll over provisions (use gains
to invest in new assets without incurring a current tax liability, tax will be deferred to a
future date) if they arise from assets that are in a trust.
Discretionary Trust
Discretionary Trust: A form of trust where the trustee is given the authority to decide the amount of money that is given to the beneficiaries. Most commonly used by families. Advantages
. The trustee has the authority to determine which beneficiary receives the assets and income from the trust. This can be an advantage in certain scenarios such as tax
planning. This makes a discretionary a more flexible structure than unit trusts, companies or partnership where distribution is related to the proportion of ownership
in the structure a beneficiary or owner has.
Disadvantages
. 7.
Answer Lin’s question about the family trust. -
John has a family trust with a corporate trustee that passively holds significant investments from developments John has done in the past.
o
should Lin obtain one too?
-
Explain that this is a discretionary trust – who would be the trustee?
-
Does a discretionary trust feature in your recommendation?
-
Any further advice needed?
We do not recommend that John and Lin use a trust to purchase and operate VeryBelle Homes. The reasons have been outlined previously and they include, its current structure,
lower changeover costs and the separate legal identity which will act as a way to protect their assets, and the lower rate of taxation.
Lin is interested in a family trust.
o
Also known as discretionary trust. The advantages and disadvantages were mentioned earlier in the presentation.
o
It is an option for Lin to transfer part or all of her investment in the company, or any other investments that she has into a discretionary trust for the purpose of distributing income to her family. This would offer her the flexibility of apportioning the income that she receives from the trust in the most tax advantaged manner possible, if the trust deed allows for it.
o
This would in a way combine benefits of apportioning income that trusts can provide and the benefits of structuring a business as a company.
o
This is not a necessary step to proceed with the purchase and transfer of the business into John and Lin’s possession. However, further discussion and analysis of Lin’s family’s financial position and financial objectives are required to determine whether this is a suitable path for Lin and her family.
8.
Advice from other experts
.
-
Address what other expert advice the clients should obtain.
-
Remember we are not allowed to give financial advice – make referrals?
Additional Advice
·
Purchasing a business is a complicated process and while we will be able to support you through the legal portion of this transaction, we advise that you consult advisors with expertise relating to certain matters so that you can make the best decision possible.
·
Accountant/Financial Advisor
: An accountant or financial advisor is recommended as they will be able to help you understand the state of the businesses
financial position at the time of purchase. This would include analysis of the business’
tax position, balance sheet, profit and loss statements and other financial records.
·
An experienced accountant would be able to provide valuable information based on
the documents that you have been provided such as the estimated profit and loss statement. The accountant can provide insights on the business performance of VeryBelle Homes by identifying operational trends such as rising expenses, comparing performance of similar companies and forecasting future business performance.
Valuer
: If you are interested in pursuing equity financing, in which you raise capital through selling shares, you will need an accurate valuation of your business. The valuer will make assessments on the business by analyzing its balance sheet and provide you with an informed estimate on its valuation as a result. The Valuer will
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also be able to analyze the value of the business assets that will be acquired in this transaction such as the architectural plans, computers and software, its vehicles, the plant and the office and determine their market value. This will help you as the purchasers be better informed whether you are acquiring these assets at a favourable market value. While we may recommend that you utilize these services, the decision is up to you whether to seek their advice.