The under capitalisation of business is the major cause of business failure within the first five years of operation. The lack of financial resources places an every increasing stranglehold on the opportunities and growth of small business.
Capitalisation is the starting point of any business. Without capital or financial resources, no business can start up and operate. However, whether there is enough capital, or too little, is not dependant on the success, or failure of most small businesses. The lack of capital in many incidents creates a greater desire and determination to work harder, longer, to achieve the goals of the busines. The more difficult it is to achieve these goals the greater the effort and intensity. Each dollar that is spent is spent with reluctance.Careful consideration must go into each and every decision that is made as the lack of financial resources could mean the end of the business, if the wrong decision is made. Careful planning, and to some extent, taking a risk on your own opinion, or judgment is necessary to succeed. Under capitalisation can foster a culture of prudence, capable of directing the business in a cost effective manner, in some future time horizon, as the business grows and enjoys greater financial buoyancy.
Maintaining a Standard of Excellence
The standard of excellence in every facit of the business is fundamental to business success or failure. The business must maintain a high level of workmanship and professionalism in the service or products in produces. These are the long-term building blocks underpinning each and every successful business. Without the quality of workmanship in the products or services produced by the firm, the business’ longevity is restricted to a continuation of finding new short term customers on a regular basis. A high standard of workmanship and professionalism means that the business can stand behind each and every product or service that it produces. The quality in workmanship means that new customers will be turned into life-long customers. It is far better to have new customer, or client, that spends $1,000 per year for 10 years, than a new customer, or client, that only spends $1,000 for one year.
By maintaining a high standard of quality and excellence in the service or products produced the business will be able to pick the type of quality client to nurture a long-term relationship, built on trust, rather than solely on price.
Business Client Structure
The survival of small business is dependant on the number of customers, or clients, the business has overall, and the value each client, or customer, in percentage terms, spends with the firm.The building blocks of a house is to have many bricks supporting the structure of the house, not just one. This same physical and philosophical approach to building can also be applied in small business. For instance, having only 50% of the house being supported by one large brick will make the house vulnerable to collapse. A business is exactly the same as having one client, or customer providing 50% of your sales, will also make the business vulnerable to collapse. The load should be spread more evenly over all the firms’ clients to ensure that the business’ survival is not dependant on one client, but many clients.
Getting the business structure right from the beginning can be one of the main determinant that ensures the success or failure of a small business. The business structure is dependant upon the number of participants and the amount of initial capital contributed by each party. If there is limited capital being contributed by an individual undertaking a business venture then the best structure to use in these circumstances is a sole trader. An individual or sole trader is the most less expensive method of starting a small business. The main downside to using this type of structure is that there is no asset protection from creditors. The small business operator trades with all his or her assets on a daily basis. The private assets of the individual can be called upon to repay debt incurred in the business. This type of structure is only appropriate to a very small business with a limited turnover. It would not be financially viable to advance to the more expensive administrative structures such as a company or trust.
Normally, small business ventures are two, or more individuals, coming together, pooling their assets and skills, in the forming of one business. Again, the most less expensive structure to set up is a partnership arrangement between the participants to which a partnership agreement will determine the terms and conditions of each partner. However, the partners are still vulnerable with no asset protection against creditors, in the same manner as a sole trader.
The best structure to reduce the exposure to creditors and provide asset protection is a company. The company structure has the same legal standing as a natural person at law. A company is a separate legal body operating in its own right. The company can only be brought to account for the assets and liabilities within the company. The directors’ and shareholders‘ personal assets are separate and therefore protected from the debts incurred by the company. Nonetheless, some creditors like financial institutions require directors’ guarantees, or personal guarantees, against loans provided to the company. These creditors become secured creditors to which the directors, not the shareholders, have given personal guarantees and are liable for the debt.
The responsibility to avoid the company’s debts is limited in circumstances where the entity has been incurring debts with no possibility of repaying them. This type of action by directors is called insolvent trading. The directors of the company knowingly incurred debts without the entity having the financial ability to repay those debts when they fell due and payable. This is a breach of the Corporations Law under Sub Sec 588G(2) to which the directors of the company can be held personally liable for the debts of the company whilst insolvent trading.
A trust structure is used for a variety of reasons in respect to taxation minimisation and asset protection. There are different types of trust structures that produce outcomes in either fixed or variable returns. The most popular asset protection trust structure in use is a discretionary trust. This trust structure states that no beneficiary is presently entitled to either capital or income from the trust until the trustee so determines in a year of income. This means that the beneficiaries has no income or capital entitlements from the trust until the trustee determines. The discretionary power to distribute capital or income to one beneficiary, over another, is the sole discretion of the trustee. The asset protection quality of a discretionary trust is found in the discretionary power of the trustee as the beneficiary has no assets or income until the trustee so distributes in a given year of income. The same discretionary power is used effectively in minimising the income or capital gains tax of beneficiaries as the taxation consequences of a trust are at the beneficiary level, not the trust. The trustee has the benefit of distributing income or capital to those beneficiaries on the lowest tax bracket, reducing the overall level of tax payable.
A unit trust provides a fixed proportion of either income or capital in a given year of income. The trustee has no discretionary to alter the fixed proportion of the entitlement to each beneficiary. The beneficiary becomes entitled to their proportion of the income or capital of the trust at the year end balance date of the trust. These types of structures are used when two or more parties come together to complete a project. Each parties entitlement is fixed.
The taxation consequence is that the trust cannot retain profit so all income and capital must be distributed to beneficiaries in any given year of income, unlike a company that can retain profit.