Is your business structured correctly?
Businesses in the marine industry, while governed by the same rules and regulations as other general businesses, operate in their own peculiar commercial realm requiring legal needs to be tailored to fit. From the owner operated mobile shipwright through to the big dealerships buying and selling large vessels these businesses operate in an economy that is not only seasonal but when the economy crashes the boat account is the last to be paid, if at all.
Several questions should to be considered: does the structure of your marine business fit your needs now, in the future, and does this fit with the business environment?
This article can not provide the definitive answer in all cases but will go some way to assisting the business owner to assess their own circumstances, ultimately resulting in more questions requiring answers.
Not unlike those questions asked when choosing a vessel, some issues to be considered when choosing a business structure are establishment costs, exposure to risk/liability, tax benefits, the business needs and ultimately business succession.
Considering the first business example of a mobile shipwright who has commenced business for the first time, is self employed and wants to keep costs to a minimum, in this situation the most obvious business structure is a sole trader. This structure allows the owner to:
• Have full control of the business;
• Be entitled to the entire profits of the business;
• Be entitled to sell or to discontinue the business;
• Close the business with minimum legal cost.
However, the owner is exposed to all liabilities for the business debts and for negligence claims and will require the relevant insurance to limit liability. Public indemnity and other negligence based insurances will assist and key person insurance can protect income when or if the owner becomes sick so that debts, running and living costs can be paid.
The main criticism about this structure is the owner is exposed to the risk of being sued for debts the business cannot pay, remembering the economic vulnerability of the industry due to seasonal change and economic down-turns, and ultimately facing personal bankruptcy in the most extreme cases.
Other problems the individual owner may find are:
• The work won on contract may be limited to small jobs as his business may lack credibility when compared to larger repair businesses that are formed under a company structure;
• Relying upon his/her own management skill;
• Business loans are more than likely be secured against a family home.
Before commencing the business under this structure the owner should consider where the business wants to be in the future as the sale of the business to a new company structure may require the payment of Capital Gains Tax.
Further, business succession planning should be considered given the success and continuation of the business is tied to the ability and health of the one owner.
Continuing with the theme of the shipwright, a partnership is proposed where the new partner brings an almost identical business to the table allowing the composite business to benefit from an expanded service area, shared business systems, increased capital and machinery and shared experience. The legal and administrative procedures and costs of formation of the partnership are relatively inexpensive.
Some disadvantages are:
Each partner is joint and severally liable for debts and the conduct of each other in the business;
• There is potential for disputes and breakdown in the mutual trust between the partners, rendering the business unworkable and damaging business reputation;
• The partners are not a separate legal entity requiring the participation of both partners for many legal transactions.
• The shipwrights in this scenario can avoid many of the potential problems that often go with partnerships by entering into a thorough partnership agreement from the start that covers everything from ownership percentages, conflict resolution through to issues of succession. Further, at this early stage the partners should consider whether a company structure would be more prudent given the tax benefits and other benefits as discussed further in this article.
Under the partnership structure the importance of succession becomes even more important so that there is an understanding of the when and how and on what terms one partner can divulge themselves of their part due to retirement, disability, sickness or accident.
Finally, where sole trader-ships are relatively simple to dissolve, in a partnership where termination is due to a dispute there may be considerable legal and other costs incurred by the partners.
Our shipwright mates, prior to forming their partnership, are approached by a marina operator who wants to incorporate their expertise in to a single one stop shop where the customer can purchase new, fully imported and locally produced vessels; have the vessels maintained and serviced; stored in dry storage or on the marina; and sell or trade-up vessels.
This venture will need considerable capital expenditure and while the potential of the business is great so are the risks; they have received legal advice on the basis that the best structure would be a company.
Listed here are some of the advantages a corporation structure:
• Perpetual succession (until wound up or dissolved) and this continuance is not affected by the death or withdrawal of shareholders. Therefore, the owners of the business/company can more easily divulge themselves of their interest;
• Considerable flexibility in the organisation, management and financing of the corporation, as:
a) Share capital can be raised due the large number of shareholders while partnerships are generally restricted;
b) Shareholders can have varying entitlements to dividend and control;
c) If the corporations grows in size it may be listed on the stock exchange;
d) Subject to compliance with statutory requirements funds may be raised from the public.
Shareholders generally have limited liability and are not liable for the debts of the corporation.
Furthermore, one of the main advantages of the corporation structure for the directors is it provides a business structure whereby, provided they are not in breach of the corporation act and their director duties or responsibilities, the directors can “hide behind the corporate veil”. That is, provided no personal guarantees are given, the corporation will bear its losses and not the director.
However, while it can generally be said that finance from banks, etc, is easier to obtain, where less sophisticated corporations require finance often company directors are required to personally guarantee bank loans, leasing agreements, and rental contracts, rendering ineffective the protection afforded by the corporate veil.
Another significant advantage in utilising a corporate structure is the considerable scope for tax planning. However, trading losses incurred in the company must remain within the company and be deducted from future profits or capital gains, whereas trading losses in partnerships and sole trader-ships may be used to offset personal income.
While there are some disadvantages in utilising the corporate structure, especially if the business is small, this structure is the best structure for the business example used in this case. Even though there are increased costs and the structure will be more complex to form and maintain in terms of legal, auditing, accountancy and administration, the benefits in conducting business for example where contracts will be entered in to with large corporations far outweigh these negative concerns.
In all three business structures there are pros and cons that need to be considered before a final decision is made. Talking to a business savvy commercial solicitor who is familiar with the marine industry, a good accountant and financial advisor, your bank manager, your family and any other relevant party before heading into the wild blue yonder of your marine business is where your journey should start.
These discussions may alter your path to the future, and while the future is difficult to foretell, the planned course now will, more than likely, result with you ending up at the required port of destination.