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The seven key considerations for tech start-ups choosing a business structure

7:14AM | Tuesday, 9 July

Most tech start-ups have aspirations of building a scalable business with global reach. Initially, their focus is firmly on technical development to produce a useful and saleable product, device, app, software or tool.   In these early stages of development, implementing a robust commercial structure might seem like a distraction that is best left until later. Get the technology right first, then figure out the detail when the business actually makes a sale, starts to expand or grow and operational issues become more necessary to address.   Unfortunately, relegating your business structure down the list of priorities can also cause problems down the track. Once you get started, tax and legal impediments can make it complex and costly to change your structure mid-course.   Let me give you an example. Most aspirational tech start-ups will engage in several capital raising rounds with a number of different investors. Typically, each round will attract its own terms and conditions, with an overriding shareholders agreement that binds these terms. These terms will typically include the type of shares that have been issued by the business; which entity the shareholder owns shares in; preference rights; anti-dilution and right of first refusal clauses.   With legally binding agreements in place, it can be complex to change a structure without affecting these shareholder rights. In most cases, every shareholder would need to agree before this change can happen.   Also if the restructure isn’t implemented carefully, you could also find it triggers an unwanted tax liability for the business or its shareholders on the unrealised value of the entity. This could happen at a point in time before the business has actually generated any surplus cash to pay for these liabilities.   Avoiding these situations makes it important to think ahead and obtain advice early. Establish a structure that is both robust, but flexible enough to support the business and its activities now and into the future, and you’ll have invested some effort up front that provides many positive returns to you, over the life of the business.   Here are my seven key considerations for tech start-ups choosing a structure:   1. Tax   Tax is an important consideration, but it should not be the key driving force for choice of structure.   You need to consider how the structure is taxed on its profits, how your personal income and drawings are treated and how any capital gain that you may make on the sale of the business will be treated, in order to maximise your return upon sale.   But tax is only one consideration in the mix, along with the other commercial needs and objectives you have for the business as outlined below.   2. Investor-friendly and ready   It’s important to think about the funding needs of the business and your options for obtaining funds.   For businesses that intend to raise capital through private equity, the structure needs to be both investor-friendly and investor-ready. Almost all professional investors will only invest in a business with a corporate structure, as it has clearly defined shareholders rights. They also have the assurance of a corporate structure being governed by the Corporations Act and administered by the Australian Securities and Investments Commission (ASIC).   Another funding option might be government grant programs. In many instances, only companies are eligible to claim or apply for these programs, which can provide substantial amounts of cash to support business activities. The Research & Development Tax incentive is one example.   I have seen many start-ups set up complex trust structures to achieve a great tax outcome, which is only useful if and when the start-up gets to a taxable position. But in the meantime, the structure is unappealing to investors and limits their ability to access government funding, which affects the opportunities, growth and value of the business.   3. Intellectual property protection   Central to the core of most tech start-ups is some form of valuable intellectual property (IP) that has been developed. In the early stages, this IP will usually be developed in a structure which then becomes the trading entity. The IP could be protected by a patent, or other rights such as a copyright, but also needs to be protected from the trading and operating risks that arise, when the business starts dealing with the outside world. This is usually achieved by having the IP in a separate structure to the trading entity. The IP entity will then license the use of the IP to the trading entity.   Forward planning is also needed when deciding which entity will own IP, as moving IP from one entity to another can create legal problems and where the IP has value, you could also find you crystallise an unwanted tax liability as well.   This article continues on page 2. 4. Employee share schemes   At some stage most start-ups will want or need to issue shares or options to their staff. Whilst employee share schemes in this country currently have some unattractive tax ramifications (that we hope the new government review will rectify), they are still an important tool for cash-strapped start-ups to motivate, reward and retain key employees.   Make sure your structure and supporting investor and shareholder agreements will allow for employee equity to be issued in the right entity. A corporate structure is generally required for employee share schemes.   5. Commercial acceptance and operations   It’s important to have a structure that is commercially acceptable and easy to deal with. This is not so important if you’re dealing with individual consumers, but if your customers are other businesses or government departments in particular, they can have strong opinions about the type of business structures they will engage with. Most government departments, for example, will only deal with corporate structures. Banks, insurers, landlords and other third parties important to the operation of your business can also treat businesses differently based on their structure.   You also need a structure that is scalable and can grow with your business and its changing needs. Once again, this comes back to planning for the future and choosing a structure with flexibility to accommodate different opportunities the business might face as it evolves through various stages of growth and maturity.   6. Internationalisation   Many tech businesses are now doing business overseas. They either establish operations in overseas countries or relocate their head office and entire business overseas, in order to expand and raise capital. If this is a likely outcome for your business, then you need to put in place a structure that allows for this at the outset.   Where you’re considering relocating your head office or setting up a holding company overseas, then this is usually best achieved by implementing what is referred to as a "corporate flip up" structure.   7. Exit   A successful exit is what most aspiring tech start-ups strive for. Having a structure that provides choice and flexibility as to how you might sell the business is important.   In the case of a company structure, you have a choice to sell the shares in the company or the business separate from the structure. Each option has different commercial and tax implications and both are important to your investment in the business, and that point in time when you eventually want to realise and extract some or all of it.   Marc Peskett is a director of MPR Group, a Melbourne based business that specialises in providing business advisory, outsourced accounting, tax, grants and funding services to technology start-ups.   You can follow Marc on Twitter @mpeskett

Seven reasons why you shouldn’t be afraid to raise your prices

6:49AM | Wednesday, 12 June

It’s usually at this time of the year when business owners sit down and start working on next year’s budget. For most businesses, one of the key budgeting challenges will be how to grow sales and profit.   One of the fastest and easiest ways to grow revenue and profit is to increase the price you sell your products and services for. Yet most small business owners are reluctant to do this as they fear that a price increase will put them at a competitive disadvantage and they will lose customers. In some cases this is true, but for most small businesses raising prices will make sense.   Businesses that operate in competitive, low margin markets where price is the key driver of demand are generally locked into prices set by the bigger players. If you want to win business you have to be cheaper or offer more for the same price. However, outside of these types of markets, price could and should be used as a tool to grow revenue and your bottom line. Here are seven benefits of raising prices:   1. Raising prices is a far easier and more effective way to grow than trying to win new customers. It is estimated that it costs seven times more to win new business than it does to sell to existing customers.   2. Raising prices has a far bigger impact on the bottom line than selling more. As costs generally do not increase in the same proportion as the price rise, most of the price increase will result in additional profit.   3. Price also makes a statement about the quality of what you are selling. If your price is too low, the buyer thinks there must be something wrong with it and you end up attracting price shoppers who are not the most loyal of customers.   4. Raising prices will force you to compete on other factors than price alone. To justify and sustain the price increase you may need to increase service levels or package into your offering high value but low cost items that take the risk out of purchasing your product or service. For example, offering guarantees, providing friendly return policies, etc. Competing on value is more sustainable and profitable than competing on price alone. 5. The fear that if we increase prices we will lose customers is a common concern. Yes, there may be some clients and customers who are with you right now just because of your price. But generally they are a minority. Perhaps you need to lose some of the clients who expect low prices, in order to make room for clients who are willing and able to pay the prices that reflect your true worth.   6. Although you may lose customers, the price increase generally still results in increased sales and profits. There is a calculation you can do to work out how many customers or volume you can afford to lose before you become worse off. For example, if you operate with a gross margin of 60% and you increase prices by 10% you will need to lose 9% of your customers or volume before the price rise has a negative impact on your financial performance. It is important to understand these numbers so you can assess the likely impact of any price increase and where your breakeven point is.   7. Raising prices is often essential just to maintain your existing profit levels. Most businesses suffer from “cost creep” where costs are slowly rising due to inflation and wage adjustments amongst other expenses. If you don’t increase prices to keep up with cost increases, you will find profits being slowly eroded.   So before dismissing a price increase or jumping to the conclusion that implementing one will be detrimental to your business, take a moment to stop and consider the upside. Maybe even ask your accountant to model the impact of a small increase for you.   You may find a price increase will provide you with a substantial improvement on your cash position, which you can use to fund those other marketing and lead generation strategies you implement in addition.   Marc Peskett is a Director of MPR Group a Melbourne based business that specialises in providing, business advisory, tax, grants and funding services and outsourced accounting to small and medium enterprises.   For a free initial discussion about setting a business budget and cash flow forecast for next financial year, contact MPR Group on 03 9869 5900.   You can follow Marc on Twitter @mpeskett

The ins and outs of investor agreements

5:32AM | Wednesday, 29 May

In my last blog, I addressed the issue every new business owner faces of where to obtain their start-up capital. I focused in particular on issues to consider when utilising family and friends as investors in the business.   This week, I’d like to delve a little deeper into formalising funding arrangements by drawing up investor agreements.   Start-ups that enter into arrangements with any type of investor should always formalise those arrangements with a legal agreement.   Agreements serve the purpose of providing a written record of the understanding the business owner and their investors have about the arrangement and the specific terms they are agreeing to. Having these terms documented is always wise when it comes to matters concerning money and to protect both parties in the event that their circumstances change and decisions need to be made or revised as a result.   Formal agreements also provide the opportunity for business owners and investors to consider and agree how they will handle situations that you don’t necessarily expect to arise, such as a dispute, death or early exit.   The bare bones of an investment agreement should include the following:   Date, names and addresses of each of the parties entering into the agreement. The amount of money being invested, how the investment will be used and what the investor can expect to receive in return for their financial contribution. Payment terms including when and how payment is to be made, whether in one lump sum or spread across multiple payments, listing the dates and amount of each payment to be made. Any deliverables to be achieved by certain dates or products and services to be developed and when they are due to be delivered. The term of the agreement and how long it is valid for, as well as the return on investment to be delivered and how the agreement will be terminated. Options for how each party can terminate the agreement early should also be outlined.   Beyond that there are different types of agreements you might put in place, depending on the role the investor will play. Below is a quick summary of the additional elements these different types of agreements might include:   Shareholders or partnership agreements   Objectives – The specific aim of the business and activities it will perform. Roles and responsibilities – What each shareholder is responsible for and will do. What decisions they can make individually and which ones require all shareholders to be involved in making, like selling the business. It should also spell out what remuneration each shareholder will receive. Profits – How they will be used and whether they will be reinvested for an initial period or distributed to shareholders that want to take the cash. Additional funding – How the company will be funded to meet the growth, operational and development needs of the business. Exit – How shareholders can exit and who they can sell their shares to. How the value of the shares will be determined. How to handle the death of a shareholder and whether their shares will be sold to existing shareholders, or if the deceased estate and beneficiaries can retain ownership and what their role and rights will be in relation to business decisions. Restraint of trade – Whether shareholders can have interests or a role in other businesses including similar businesses. IP ownership – Who owns intellectual property brought to the business or developed by it. What will happen if a shareholder than brought IP to the business decides to leave? Dispute resolution – How disputes will be handled and resolved. Will mediation or an independent expert be brought in to resolve the matter, so it doesn’t have to proceed to court and incur costs for doing so?   Angel investor term sheets or agreements   Seat on the board – Angel investors will typically expect to have a seat on the board of the company and therefore a voting right in business decisions. Equity type – There are different types of shares that can be issued by a company. Initially, a start-up company might issue ordinary shares, or the same type of shares that the founding owners hold. As the business grows and develops it might structure things differently and issue different types of shares that provide different entitlements to the shareholders, such as preferred convertible shares. Angel investors will want to be clear about what class of share they are obtaining with their investment. Anti-dilution clauses – These are clauses designed to protect the conversion price of the shares that angel investors hold, which may be affected by additional funding provided to the business. While some dilution is likely to occur, those that invest early on and bare a greater burden of risk will want to see better returns and reward to match that risk, compared to later investors who come on board when the business concept has been proven. Right of first refusal – This is the first right to purchase shares held by other investors before they are offered to an outside party. This enables an angel investor to consolidate their ownership. Liquidated preference – Terms designed to ensure the investor gets their investment back in the event that a business owner decides to sell early and potentially at a loss to the investor. Venture capital term sheets   The terms here will be much the same as for angel investors, with a few additional clauses:   Information and management Rights – VCs might require certain information and reporting to be provided on a monthly or some other regular basis so they can monitor the progress of the business. Restrictions on sale of shares – Because the business is often tied to the expertise of key founders or employees, investors might place restrictions on the ability of those founders to sell their shares, until such time as the investors have sold their interest and made an appropriate return on their investment. Exit strategy – VC investors typically expect to realise their investment through a trade sale, float or IPO, so might include the right to make this happen within a certain timeframe. Alternatively, they might incorporate a clause to force the founders to buy their shares back.   Regardless of the type of investor’s agreement you end up entering into, there are a couple of key considerations you should always have at the outset.   Here are my top five tips for business owners planning to bring an investor on-board:   Be clear about your reason and objectives for obtaining an investor. Give detailed thought to what your investor wants to get out of the business. Establish a fair means for rewarding each of your dollar and “sweaty-equity” investments. Expect the unexpected, plan for it and deal with it as soon as an issue arises, to prevent it from escalating. Seek financial and legal advice.   Marc Peskett is a Director of MPR Group a Melbourne based business that specialises in providing, business advisory, tax, grants and funding services and outsourced accounting to small and medium enterprises.   MPR Group are holding a full day workshop on 21 June to help business owners including start-ups, develop their annual business plans and budgets. To register click here.   You can follow Marc on Twitter @mpeskett

R&D Tax Incentive deadline looms: What you need to know

3:29AM | Friday, 15 March

A tax expert has issued start-ups some advice about the R&D Tax Incentive, namely in relation to the eligibility criteria and recordkeeping requirements, as the April 30 deadline draws closer.

Seven top tips to help make your business ‘lucky’

3:32AM | Wednesday, 13 March

In my last blog I wrote about the need to remain relevant. This week I want to talk about how smart businesses use the market to evolve their business model or do what is commonly referred to as a “pivot”.

The race to stay relevant is on

2:43AM | Wednesday, 20 February

One of the biggest challenges for businesses today is remaining relevant. Innovation and the rate of change have never before been this rapid and the impact is significant on business.

Three tests to see whether your start-up is investment ready

2:27AM | Wednesday, 6 February

Start-ups looking for cash might consider equity as an option to fund their early stage and ongoing funding requirements.

The power of being on trend

1:38AM | Wednesday, 23 January

The best predictions for SMEs in 2013 will come from what we know. The great news is, if you’ve been operating your business since the start of the financial year, you already know a lot and have access to information you can use to spot any trends happening in your business.

Choosing your online revenue model

1:41AM | Wednesday, 9 January

We know that starting an online business can allow for a faster launch than traditional bricks and mortar businesses.

Five key things that fast-growth businesses do well

12:05AM | Thursday, 20 December

But it’s perhaps more useful to look at the common characteristics of fast-growth businesses, rather than the rate of growth itself.

Biting the management bullet

12:21AM | Wednesday, 12 December

There’s a point on the growth path of every start-up, when the founder of the business needs to make the decision to bring management talent into the business.

Taxing times for start-ups with global ambitions

11:14AM | Wednesday, 28 November

With the increasing globalisation of business, more and more SMEs are doing business overseas either directly by establishing a presence in another country or more commonly over the internet.

Five key reasons why start-ups fail

11:35PM | Tuesday, 20 November

In a lively speech delivered last week, former opposition leader Malcolm Turnbull covered everything from hard hats and fluoro vests to the embracing of “creative destruction” in his critique of Australia’s start-up scene.

Top 10 ways that complacency hurts your start-up

11:25AM | Wednesday, 14 November

Much like parenting, there’s no magic guide for establishing and building a successful business.

The triple C bottom line: Getting back to basics

10:47AM | Wednesday, 31 October

It’s easy to get caught up with lots of ideas and exciting opportunities to pursue in business, but unless you get the business basics right, chasing or implementing the latest whizz-bang idea, management fad or marketing strategy won’t get you the results you’re looking for. Instead, they’ll be a distraction that you can’t capitalise on.

Five advantages to becoming a franchisee

10:49AM | Wednesday, 17 October

When you decide to become a business owner, there are a few options you can choose to pursue that goal. You can start your own business from scratch, buy an existing independent business, or buy a franchise.

Taking stock of your first quarter

10:27AM | Wednesday, 3 October

We’ve just come through the first quarter of the financial year, and every business owner should be looking at how their business has performed, what has worked and what hasn’t and how they can use that to their advantage as the year rolls on.

Five questions you should be able to answer

9:23AM | Wednesday, 19 September

Time and time again, I find myself talking to business owners, both start-ups and those that have been operating for some time, who are unable to clearly and confidently answer some simple questions you would assume they should know.

When buying is better than starting

9:48AM | Wednesday, 5 September

If your business has been up and running and you’re looking for a new growth strategy to take it up a notch, you may want to consider an acquisition.

How to avoid a start-up information overload

8:59AM | Wednesday, 22 August

Start-up businesses have never before had so much rich, diverse and useful content and so many tools available online and at their fingertips.

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